LESSON 4: TYPES OF LOANS -- ADJUSTABLE-RATE MORTGAGES (ARMs)

Adjustable-rate mortgages, or ARMs, differ from fixed-rate mortgages in that the interest rate and monthly payment moves up and down as market interest rates fluctuate. Most have an initial fixed-rate period during which the borrower's rate doesn't change, followed by a much longer period during which the rate changes at preset intervals. The rates charged during the initial periods are generally lower than the rates found on comparable fixed-rate mortgages. After all, lenders have to offer borrowers something to make it worth their while to assume the risk of higher rates in the future!

The initial fixed-rate period can be as short as a month or as long as 10 years. One-year ARMs are the most common, though so-called hybrid ARMs have become more popular in recent years. These hybrid ARMs -- sometimes referred to as 3/1, 5/1, 7/1 or 10/1 loans -- have fixed rates for the first three, five, seven or 10 years, followed by rates that adjust annually thereafter.

Adjustable-rate mortgages (ARMs) are favorable when rates are going down or your salary is going up. Otherwise, each rate adjustment can sting.

After the fixed-rate honeymoon, an ARM's rate fluctuates at the same rate as an index spelled out in closing documents. The lender finds out what the index value is, adds a margin to that figure, then recalculates what the borrower's new rate and payment will be. The process repeats each time an adjustment date rolls around. See Tip 1

Borrowers have some protection from extreme changes because ARMs come with caps. These caps limit the amount by which ARM rates and payments can adjust at any given milestone. See Tip 2

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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

Here's a cheat sheet of terms to remember when shopping for an ARM: More on ARMs