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Adjustable Rate Loan

How Does an Adjustable Rate Loan Work?

With an adjustable rate mortgage loan, there is usually an initial time period of 3, 5, or 7 years during which the interest rate is fixed and doesn’t change.  After this set period of time, the rate can change based on the index and margin. Each adjustable loan rate is tied to a specific index which is a fund or a security.  The Margin is the amount the lender adds to the index for their profit.  Combined they make up the adjustable rate.  Once the fixed period is over and the new rate is adjusted, it can change every 6 or 12 months depending on the term of your specific loan.

Advantages of an adjustable rate loan:

Many people who work with an Adjustable Rate Loan go into it with the plan to keep the loan for only the initial time when the rate is fixed.  This is because it is usually quite a low rate to begin with, so the payments will be lower than if you had a fully amortized fixed rate loan.  The savings each month is one of the best reasons for choosing this type of loan.

Disadvantages of an adjustable rate loan:

 Problems with this type of mortgage begin when homeowners choose this loan because it is the only way they can get approval.  Then, when the adjustment period is reached and the payments jump higher, they can no longer afford the payment.  If you go into this type of loan remembering that the reason for the loan is the short term, then you won’t get stuck with those higher payments.  However, there is always the risk that the market will be down and you won’t be able to sell the home in five years when you want to, so you need to be prepared to handle the higher payments.