Continuing with our series, Fourteen Ways to Finance Your Home, let’s talk about flexible rate mortgages. One question, are they right for you? These loans go by several names — “flexies,” “adjustables,” “ARMS,” “floaters”– but they share one common trait: NO FIXED RATE. The lender increases and decreases the interest rate periodically, according to the fluctuations of whatever financial index that is agreed to by the borrower. Since the flexible is a long-term loan, it is renegotiated periodically and “rolled over” at the new rate, with a new payment.
Here’s an example: Taylor gets a flexible rate mortgage that offers these terms: The first year, he makes mortgage payments based on an interest rate 1/2 of 1% below today’s going mortgage interest rate. A year later (and every year after), payments are adjusted to reflect changes in the mortgage rate — up or down.
There are many variations: Some flexibles provide that mortgage payments won’t be adjusted by more than a fixed dollar amount during each adjustment period. Others “cap” the interest-rate changes that can be made during each adjustment period.
Advantages: Lenders almost always offer these loans at an initial below-market rate. Interest -rate drops must be reflected too. There is no fee for renewing a flexible and no penalty for paying one off ahead of time.
Disadvantages: If interest rates head upward after you buy the home, your monthly payments will go up too. This adds an element of uncertainty to the biggest single component of your budget. Even worse, with some flexible rate mortgages, all of your monthly payments might be allocated to interest in high-cost periods. The result of this is that you do not build equity in your home.
Money-Saving Move: Shop around among lenders before taking out any kind of flexible rate mortgage. Learn about the various indexes that lenders use to determine rate and adjustments. Find a lender that uses the least volatile index to determine the changes in your interest rate. Learn what is involved when the lender promises you “caps” on interest and payments.
You could get a bargain by taking out a flexible rate mortgage with a below-market rate with frequent adjustments during a time of falling interest, but it is a gamble.