Adjustable Rate Mortgage

A mortgage is a type of debt instrument. It is characterized by the backing of collateral of specific real estate property. In case of default in repayment the lender will have rights in the specific collateral.

Under various types of mortgage loans there is the Adjustable Rate Mortgage. The peculiarity of these types of loans lies in the fact that it blends the fixed rate mortgage with the variable rate mortgage by having a fixed interest rate payment period initially and then changing into variable interest rate after a specific date known as the reset date. This is also called Fixed Period Mortgages. However caution must be exercised since an upward movement of the benchmark interest rate can increase the interest burden manifold.

There can be different variations in structuring of Adjustable Rate Mortgages (ARM) apart from the above mentioned Fixed Period Mortgage. In the next part we discuss some of them.

The mortgage where the borrower has several options with regards to the type of payment to be made to the lender is known as Option Mortgages. The choice can be of making payments of interest and principal or alternatively making interest only payment or minimum payment. It is seen that in case of Minimum Payment the principal amount can get higher later on as after the initial low interest rate ‘teaser period’ the rates return to market levels and the small amount paid initially does not even cover the total interest charges which gets added to the principal later on, thus increasing it.

The Indexed Mortgages are the ones where the interest rate is fixed on the basis of a specified benchmark index like LIBOR. The interest rates adjust periodically to the benchmark and the frequency of resetting; reset dates etc are all specified in the contract. The margin over and above the index is fixed but the index itself is variable with both up and down movements. There can be sometimes a cap on the amount of interest that can be charged. This is the only type of mortgages offered in U.S. However in Europe another variation of this types are available known as the Discretionary mortgage where the parties can reset the interest rate any number of times and for any reason agreed upon by giving suitable notice.

In case of the Interest Only Mortgages initially the interest is paid only after which the mortgage gets amortized and gets paid at the end of its period. This means the payments increase in the later half resulting in payment shock.

One of the variations of the Fixed Rate Mortgage is the Hybrid Mortgage. Unlike the Fixed Rate Mortgage the variable portion of this mortgage do not have a fixed margin added to the benchmark index rate after the fixed interest period gets over. This margin is also variable.

Flexible Rate Mortgages are the ones which allow the borrower the option to chose from different payment options like every month: 30-year, fully amortized payment; 15-year, fully amortized payment; or interest-only payment or a "minimum payment". These are popular in the rising home prices scenario.

Finally we have the variations of the Payment Option Mortgages which allows the borrower to choose from several monthly payment options. The calculation of these minimum payments is based on initial temporary start interest rate. While the temporary start interest rate operates it is a fully amortizing payment. After this period expires, payment remains a monthly option but in case of a payment which is less than the scheduled interest-only payment deferred interest is created.

Secure Option is a variation of the Payment Option Mortgage wherein it differs from the above as it has a fixed payment period after the expiry of the temporary monthly start interest rate period. This obviously offers more security from payment shocks for the borrowers.

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