Adjustable rate mortgage

From ArticleWorld

An adjustable rate mortgage is a loan secured on a property, like a house. The property’s interest rate and therefore monthly repayment vary over time. Other possible forms of mortgage loans include interest only mortgage, fixed rate mortgage, negative amortization mortgage, discounted rate mortgage and balloon payment mortgage.

Pros and cons

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.

UK vs everywhere else

Variable rate mortgages are the most common form of loan for house purchases in the United Kingdom, Australia, and New Zealand, but are also unpopular in some other countries.

For those who plan to move within a relatively short period of time they are very appealing because they often include a lower, fixed rate of interest for the first three, five, or seven years of the loan.

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 usually 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 possible initial period with a fixed rate: This gives the borrower a chance to increase his/her annual earnings before payments begin to rise.
  • a maximum or a cap that interest rates can rise in any year: If there is some sort of cap, it must be clarified in the loan document.
  • a maximum or a cap that interest rates can rise over the life of the mortgage: This also must be clarified in the loan document.