Adjustable-rate mortgages (ARMs) are home loan options with interest rates that can change depending on market conditions. Treasury bill rates and Federal policy, among other economic factors, significantly affect financial indices used as benchmarks for ARMs. Fluctuations in these factors significantly impact the interest rates of ARMs.
However, some caps and limits provide borrowers with a degree of protection from spikes in mortgage interest rates.
Distinguishing Features of ARMs
Here's a closer look at some distinguishing features of ARMs to help you understand how interest rates are determined and managed:
Indices
These publicly published financial benchmarks reflect market conditions and influence changes in ARM rates. ARM rates are contingent on several indices, including the following:
- United States Treasury Bills (T-bills)
- Bank Prime Loan (Prime Rate)
- The 11th District Cost of Funds Index (COFI)
- London Interbank Offering Rate Index (LIBOR)
Margin
This constant is added to the corresponding index value, determining the actual interest rate for that period. The margin remains consistent throughout the mortgage term, irrespective of changes in financial indices.
Initial Interest Rate
As the name implies, this is the starting interest rate of an ARM, valid until the first reset date. This rate is often lower than the sum of the prevailing index and margin to compensate for the risk of a rate increase in the future.
Adjustment Frequency
ARMs can be classified as short-term or long-term based on the timing of their rate recalculations, commonly known as adjustment frequency. For short-term ARMs, the reset date is usually every several months, while long-term ARMs can span up to 10 years between resets.
Caps and Limits
Caps and limits regulate the allowable variations in various parameters, such as the interest rate, payment amounts, reset intervals, and the maximum rate increase.
Caps and Limits for Adjustable-Rate Mortgages in Maryland
Mortgages in Maryland are subject to specific rules and limits to maintain rate stability and limit borrower exposure to risk. These include:
Initial Adjustment Cap
This limits the deviation of the first-rate adjustment from the initial interest rate. For example, an initial adjustment cap of 2% at an initial interest rate of 5% would mean the new rate could not exceed 7% or drop below 3% after the first reset.
Periodic Adjustment Cap
This provision caps the amount a rate can change at each reset date. Six-month adjustable-rate mortgages in Maryland often have a 1% periodic adjustment cap. This means the interest rate cannot increase or decrease by more than 1% at each adjustment period. On the other hand, a 2% periodic adjustment cap mainly applies to a one-year ARM.
Lifetime Rate Cap
Also known as the lifetime adjustment cap, this provision caps the maximum increase in interest rates over the life of an ARM. For instance, if a lifetime cap is 6%, your rate cannot exceed 11% (5% initial rate + 6% lifetime).
Lifetime Cap
This restricts the maximum possible interest rate during the entire mortgage term. For example, a lifetime cap of 5% would mean that the ARM rate cannot exceed 5% above the initial interest rate, regardless of market conditions.
Negative Amortization Cap
Some ARMs allow negative amortization, where the borrower can make low monthly payments that may be insufficient to cover the interest charges. The unpaid interest charges are added to the balance of the loan. A negative amortization cap limits the maximum amount of negative amortization that can occur during the life of the mortgage.
Payment Cap
Under this provision, the monthly payment amount cannot increase by more than a specific dollar amount. It protects borrowers from significant payment increases if the interest rate increases significantly.
Adjustment Frequency Limit
This cap limits how frequently the rate can change. It helps borrowers plan for potential payment changes.
When Is an Adjustable-Rate Mortgage a Good Choice?
Taking out an ARM can be a smart choice for borrowers in certain situations, such as:
- If you only plan to stay in the home for a short period, typically under five years. This way, you can take advantage of the initially lower interest rate and sell the house before your first reset.
- If you expect your income to increase in the future. This is because higher income may help you absorb any potential rate increases.
- If current mortgage rates are high but are expected to decrease in the near future. In this case, an ARM can save you money in the long run.
- If you are comfortable with some risk and unpredictability. While caps and limits offer protection, your interest rate could still increase significantly.
Secure an Adjustable-Rate Mortgage in Maryland at Woodsboro Bank
Woodsboro Bank's community banking experience and flexible mortgage options make it a trusted choice for home financing in Maryland. The bank’s competitive rates and personalized service can help secure ARMs that align with diverse financial goals. Contact Woodsboro Bank today to secure real estate financing.