Are A.R.M.s (adjustable rate mortgages) risky for a borrower?
Adjustable rate mortgages are loans that are fixed for a period of time, and then begin to adjust according to an index. A common index is LIBOR, or London Interbank Offertory Rate. This is the rate that International Banks loan money to each other. The risk of an ARM is that once it begins to adjust, and interest rates climb, it may make the monthly payment uncomfortable for the borrower. However, there are caps on the amount a rate can increase after its first adjustment. For example, lets say your loan has a 6% cap above initial rate, and the initial rate is 5%. If prevailing interest rates shot up to 15%, the principal and interest on a $100,000 loan would go from $536 to $952/ month. To protect against interest rate risk, a borrower can lock the rate for a period of time that would extend past the time the borrower expects to be in the property.
