I was disappointed to read in the LA Times  that “A new survey of 112 lenders by mortgage giant Freddie Mac found that ARMs are starting to attract applicants again. Adjustables accounted for just 3% of new home loans in early 2009 but are projected to be picked by nearly 1 out of 10 borrowers in 2011. In the jumbo and super-jumbo segments, the share will be even larger, according to Freddie Mac chief economist Frank Nothaft.”

Reasons to obtain an adjustable rate mortgage (ARM) instead of a fixed:

1) Will likely remain in the home for less than five years.

2) Planning on making a substantial principal reduction.  With an adjustable mortgage your payment will be decreased as it will be based on your paid down loan balance.  With a fixed interest rates, the principal reduction will shorten your loan term but not usually lower your monthly payment.

3) Will likely refinance in the near future and don't need the security offered by the slightly higher fixed interest rate loans.

Your adjustable loan will be tied to an index, perhaps LIBOR. Let’s assume that the one year LIBOR rate is your index and that the rate today is  .75%.  The lender expects to make a profit so they aren’t going to charge you  ¾ % interest.   They will add a margin, typically 2.25% - 2.5% or higher.  The rate is calculated based on the current index value + margin = adjusted interest rate.
 
I.E. .

.75 (current index value) + 2.5 (margin) = 3.25%  adjusted interest rate

I worked in the mortgage banking business when the adjustable loans first rolled out and they are very confusing.  Questions to ask your lender before you select an adjustable rate mortgage over a fixed rate.

1) What is the initial interest rate and if it were adjusted today, what would it be adjusted to?  What index is the adjustment tied to and what is the margin?

2) How long will my initial rate be in effect? How often is the interest rate adjusted?

3) At the time of my first adjustment what is the maximum my interest rate can be?

4) What is the maximum the interest rate can increase to over the life of the loan?

5) Is the loan assumable?

6) Is there negative amortization?

Related Post: How long should a buyer expect to remain in their home?

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