Although ARMs (adjustable-rate mortgages) are not the best option in every situation, they are helpful in certain situations when financing a home. So in this article, we explain the basics of adjustable-rate mortgages, as we specifically review LIBOR-indexed ARMs.
What is an Adjustable-Rate Mortgage?
An adjustable-rate mortgage also called also known as a “variable-rate mortgage” and a “floating-rate mortgage,” is a loan that has different interest rates through its life.
An ARM typically offers a short period in the beginning of the loan with a low, fixed interest rate (teaser rate). However, the rate changes with time. After the initial period, generally two to five years, the rate on the loan begins to adjust. Usually, when the interest rate begins to adjust, it moves upward from the low, initial interest rate. After that, the rate can go up or down, depending on the circumstances.
Although there are many benefits to taking out an ARM, borrowers should be aware of the drawbacks of an ARM, including:
- Higher interest rates after the initial period.
- Your interest rate could potentially reach the lifetime cap.
- Many Adjustable-Rate Mortgages have a prepayment penalty. This means that you’ll be penalized for paying your loan back in full before the agreed upon schedule.
Related: Mortgage Teaser Rates
Features of a LIBOR-indexed ARM
In addition to the different loan periods of the LIBOR ARM, there are various other features of this type of mortgage. A few of them are:
- The initial interest rate of your LIBOR ARM remains fixed for a period of anywhere from 6 months to 10 years.
- Once a borrower reaches the adjustment period, the loan´s interest rate is adjusted every 6 months to 1 year.
- Once the initial rate has been set, the highest rate a borrow can have over the life of the loan is often 5%-6% higher than the initial interest rate.
- The rate adjustment caps that limit the size of a rate change are usually 1% on 6-month LIBORs, and 2% on 1-year and 3-year LIBORs. On 7-year and 10-year LIBORs, however, the cap is usually 5% on the first adjustment and 2% on all following (annual) adjustments.
Benefits of a LIBOR-indexed ARM
While all ARMs have their own benefits and drawbacks, many find that LIBOR-indexed ARMs have some of the most unique benefits. Here are some of the most important benefits:
- With a LIBOR ARM, you can avoid negative amortization. This is due to the availability of periodic and lifetime rate caps.
- LIBOR ARMs feature great buydown rates. The 30-year LIBOR ARM allows you to buydown the interest rate and margin by 0.25% for only 3/8th of a point.
- Buyers can expect to receive a low margin on the LIBOR ARM. With that said, margins for subprime loans may be higher.
- LIBOR ARMs feature one of the lowest rates of all other ARMs.
- With a LIBOR ARM, you can avoid wide rate fluctuations.
If you find that you are eligible for a LIBOR ARM, you will likely find that this is one of the best options for you. As long as you do your homework, you´ll be ready to go.
Marimark Mortgage serves the mortgage needs of homebuyers, homeowners, and investors in Florida, Virginia, and Pennsylvania.
We have a great deal of experience serving the needs of borrowers who benefit from an ARM, and specialize in conventional home mortgages, FHA, VA and USDA mortgage options, refinance loans, and reverse mortgages. We’ve worked extensively with cash-out refinancing, and help clients to lower their monthly mortgage payments.