You just *HAD* to go and ask about ARMs, didn't ya? :| 
Here's the basics about Adjustable Rate Mortgages. To begin with, your mortgage payment will be fixed for a certain amount of time (usually from 1 year to 5 years) after which time your interest rate will either go up or down. It does this because your mortgage is tied to a specific index, usually either some type of treasury bill or LIBOR (London Interbank Offered Rate). which either goes up or down. Assuming you got a good rate to begin with (and you'd be crazy to consider an ARM if you didn't), it's obviously in your best interest to get an ARM with the longest fixed rate period available to you so you can lock in that good rate for as long as possible. Oh, if you're REALLY a masochist, you can look up all the rates for various T-bills and the LIBOR in most newspaper's financial section.
You also need to be aware of the "periodic cap" which is how much the interest rate is allowed to adjust by for a certain period of time (usually a year, but it can be anything) as well as the "lifetime cap" which is the highest interest rate the mortgage will ever have.
Now, let's say you have an ARM tied to Dave's Super T-bill which is currently trading at 4.0%. At first you'd say "Wow 4%! That's the loan for me!". Unfortunately, that's not the interest rate you pay. There's a not so little buffer on top of that 4% called the margin (which is usually an additional 2-3%, or at least it used to be). The margin never changes for the life of the loan so if it's 2.5% your interest rate would actually be 4.0 + 2.5 = 6.5%. What was a nice rate isn't so much any more. Generally, the margin is included in any rate you'll see advertised but it becomes important to know about if
you hold on to an ARM past it's initial fixed period as your interest rate can NEVER go below that amount, even if your index drops to zero percent. Look for an ARM with a relatively low margin and avoid any with margins over 3%.
The three most common ARMs you'll see advertised are "5/1", "3/1", or "1/1". The first number always indicates the number of years the ARM will have a fixed interest rate, the second one will be how often the interest rate will change (in these cases, yearly). However, there are "5/6" ARMs out there. Unfortunately, in this case the 6 refers to six months instead of six years.
Some ARMs (as well as some fixed rate hybrid loans) have "interest only" periods. Avoid these like the plague. They are designed solely for people who really suck at math as you are not making any headway towards actually paying back the loan.
If you go with an ARM, make sure you get a 5/1 ARM and, this is the IMPORTANT part, at the beginning of the fourth year you need to either a) plan on moving that year (and sell your home), b) refinance to a fixed rate loan, or c) refinance to another 5/1 ARM. If you do this, you can come out ahead. If you don't and you let the mortgage rate start to fluctuate, well just turn on the news and you'll see what happens.
Edit: one more thing, regardless of whether you choose an ARM or a fixed rate mortgage, make sure there is no pre-payment penalty clause in it.
Dave
Here's the basics about Adjustable Rate Mortgages. To begin with, your mortgage payment will be fixed for a certain amount of time (usually from 1 year to 5 years) after which time your interest rate will either go up or down. It does this because your mortgage is tied to a specific index, usually either some type of treasury bill or LIBOR (London Interbank Offered Rate). which either goes up or down. Assuming you got a good rate to begin with (and you'd be crazy to consider an ARM if you didn't), it's obviously in your best interest to get an ARM with the longest fixed rate period available to you so you can lock in that good rate for as long as possible. Oh, if you're REALLY a masochist, you can look up all the rates for various T-bills and the LIBOR in most newspaper's financial section.
You also need to be aware of the "periodic cap" which is how much the interest rate is allowed to adjust by for a certain period of time (usually a year, but it can be anything) as well as the "lifetime cap" which is the highest interest rate the mortgage will ever have.
Now, let's say you have an ARM tied to Dave's Super T-bill which is currently trading at 4.0%. At first you'd say "Wow 4%! That's the loan for me!". Unfortunately, that's not the interest rate you pay. There's a not so little buffer on top of that 4% called the margin (which is usually an additional 2-3%, or at least it used to be). The margin never changes for the life of the loan so if it's 2.5% your interest rate would actually be 4.0 + 2.5 = 6.5%. What was a nice rate isn't so much any more. Generally, the margin is included in any rate you'll see advertised but it becomes important to know about if
you hold on to an ARM past it's initial fixed period as your interest rate can NEVER go below that amount, even if your index drops to zero percent. Look for an ARM with a relatively low margin and avoid any with margins over 3%.
The three most common ARMs you'll see advertised are "5/1", "3/1", or "1/1". The first number always indicates the number of years the ARM will have a fixed interest rate, the second one will be how often the interest rate will change (in these cases, yearly). However, there are "5/6" ARMs out there. Unfortunately, in this case the 6 refers to six months instead of six years.
Some ARMs (as well as some fixed rate hybrid loans) have "interest only" periods. Avoid these like the plague. They are designed solely for people who really suck at math as you are not making any headway towards actually paying back the loan.
If you go with an ARM, make sure you get a 5/1 ARM and, this is the IMPORTANT part, at the beginning of the fourth year you need to either a) plan on moving that year (and sell your home), b) refinance to a fixed rate loan, or c) refinance to another 5/1 ARM. If you do this, you can come out ahead. If you don't and you let the mortgage rate start to fluctuate, well just turn on the news and you'll see what happens.
Edit: one more thing, regardless of whether you choose an ARM or a fixed rate mortgage, make sure there is no pre-payment penalty clause in it.
Dave
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