Adjustable rate mortgage
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An adjustable rate mortgage or variable rate mortgage is a loan secured on a property (house) whose interest rate and so monthly repayment vary over time. Other forms of mortgage loan include interest only mortgage, fixed rate mortgage, discounted rate mortgage and balloon payment mortgage. Adjustable rates transfer part of the interest rate risk from the lender to the borrower. They can be used where unpredictable interest rates make fixed rate loans difficult to obtain. The borrower benefits if the interest rate falls and loses out if interest rates rise
Variable rate mortgages are the most common form of loan for house purchase in the United Kingdom but are unpopular in some other countries. Variable rate mortgages are very common in Australia and New Zealand. For those who plan to move within a relatively short period of time (three to seven years), they are attractive because they often include a lower, fixed rate of interest for the first three, five, or seven years of the loan, after which the interest rate fluctuates.
Adjustable rate mortgages, like other types of mortgage, may offer the ability to repay principal (or capital) early without penalty. Early payments of part of the principal will reduce the total cost of the loan (total interest paid), and will shorten the amount of time needed to pay off the loan. Early payoff of the entire loan amount (refinancing) is often done when interest rates drop significantly.
Adjustable rate mortgages are sometimes sold to unsophisticated consumers who are unlikely to be able to repay the loan should interest rates rise, which they often do. In the United States, extreme cases are characterized by the Consumer Federation of America as predatory loans. Protections against interest rate rises include (a) a possible initial period with a fixed rate (which gives the borrower a chance to increase his/her annual earnings before payments rise); (b) a maximum (cap) that interest rates can rise in any year (if there is a cap, it must be specified in the loan document); and (c) a maximum (cap) that interest rates can rise over the life of the mortage (this also must be specified in the loan document).
Due to changes in government policy among many OECD countries, the Federal Reserve Bank (or its equivalent) is now charged with maintaining an inflation rate at a low (at or below 2 percent) level. This policy has made a significant impact on the volatility of adjustable rate mortgages, as the supply of money is more tightly controlled by the Federal Reserve, reducing the frequency and size of fluctuations in the base rate.
External links
- Consumer Handbook on Adjustable Rate Mortgages (http://www.federalreserve.gov/pubs/brochures/arms/arms.pdf) (PDF Document)
- Historical Mortgage Rates, 1977 - present (http://www.hsh.com/idxhst.html)
- Mortgage, Loan and Refinance Information: A Borrower's Guide to Online Resources. (http://www.noendpress.com/pvachier/mortgage/)