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CHAPTER III -- LOAN CHOICES APLENTY

LESSON 5: ARM vs. FRM

Which is the better mortgage option for you: adjustable or fixed?
Adjustable-rate mortgages can be very tempting to home buyers, yet they carry a great deal of uncertainty. Fixed-rate mortgages offer rate and payment security, but they can be more expensive. Here are some pros and cons of ARMs and FRMs:

ARM benefits and drawbacks:
Benefit 1) Feature lower rates and payments early on in the loan term. Because lenders can use the lower payment when qualifying borrowers, borrowers can purchase larger homes than they otherwise could buy.
2) Allow borrowers to take advantage of falling rates without refinancing. Instead of having to pay a whole new set of closing costs and fees, ARM borrowers just sit back and watch their rates fall.
3) Help borrowers save and invest more money. Someone who has a payment that's $100 less with an ARM than with a FRM for a couple of years can save that money and earn more off it in a higher-yielding investment.
4) Offer a cheap way for borrowers who don't plan on living in one place for very long to buy a house.
Drawback

1) Rates and payments can rise significantly over the life of the loan. A 6 percent ARM can end up at 11 percent in just three years if rates rise in the overall economy.
2) A borrower's initial low rate will adjust to a level higher than the going fixed rate level in almost every case even if rates in the economy as a whole don't change. That's because ARMs have initial fixed rates that are set artificially low.
3) The first adjustment can be a doozy because some annual caps don't apply to the initial change. Someone with an annual cap of 2 percent and a lifetime cap of 6 percent could theoretically see the rate shoot from 6 percent to 12 percent 12 months after closing if rates in the overall economy skyrocket.
4) ARMs are difficult to understand. Lenders have much more flexibility when determining margins, caps, adjustment indices and other things, so unsophisticated borrowers can easily get confused or trapped by shady mortgage companies.
5) On certain ARMs, called negative amortization loans, borrowers can end up owing more money than they did at closing. That's because the payments on these loans are set so low (to make the loans even more affordable) they only cover part of the interest due. Any additional amount due gets rolled into the principal balance.

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FRM benefits and drawbacks:
Benefit 1) Rates and payments remain constant. There won't be any surprises even if inflation surges out of control and mortgage rates head to 20 percent.
2) Stability makes budgeting easier. People can manage their money with more certainty because their housing outlays don't change.
3) Simple to understand, so they're good for first-time buyers who wouldn't know a 7/1 ARM with 2/6 caps if it hit them over the head. Plus, longer-term FRMs are very affordable.
Drawback 1) To take advantage of falling rates, FRM holders have to refinance. That means a few thousand dollars in closing costs, another trip to the title company's office and several hours spent digging up tax forms, bank statements, etc.
2) Can be too expensive for some borrowers, especially in high-rate environments, because there is no early-on payment and rate break
3) Are virtually identical from lender to lender. While lenders keep many ARMs on their books, most financial institutions sell their FRMs into the secondary market (more about that in
Lesson 10). As a result, ARMs can be customized for individual borrowers, while most FRMs can't.

(continued on next page)

 

TABLE OF CONTENTS

CHAPTER I
  Lesson 1
  Quiz

CHAPTER II
  Lesson 2
  Quiz

CHAPTER III
  Lesson 3
  Lesson 4
  Lesson 5
  Quiz

CHAPTER IV
  Lesson 6
  Lesson 7
  Quiz

CHAPTER V
  Lesson 8
  Lesson 9
  Quiz

CHAPTER VI
  Lesson 10
  Lesson 11
  Quiz

CHAPTER VII
  Lesson 12
  Lesson 13
  Lesson 14
  Quiz

CHAPTER VIII
  Lesson 15
  Lesson 16
  Lesson 17
  Lesson 18
  Quiz

CHAPTER IX
  Lesson 19
  Quiz

CHAPTER X
  Lesson 20
  Quiz

CHAPTER XI
  Lesson 21
  Quiz

CHAPTER XII
  Lesson 22
  Lesson 23
  Lesson 24
  Quiz

CHAPTER XIII
  Lesson 25
  Lesson 26
  Lesson 27
  Quiz

CHAPTER XIV
  Lesson 28
  Lesson 29
  Lesson 30
  Quiz

Definitions





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A call to ARMs

 
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