Adjustable-Rate Mortgages: Things to Watch Out For

Adjustable-rate mortgages are commonly offered in the home market today. These types of mortgages are very popular because, in many cases, they allow individuals to get a lower monthly mortgage payment. However, when you are considering an adjustable-rate mortgage, there are some things that you need to watch out for.

Negative Amortization

One of the biggest things to watch out for is negative amortization. For many adjustable rate mortgages, you will have a promotional period that allows you to choose a monthly mortgage payment. While this might be very convenient while you are paying it, it can cause serious problems for you down the road.

When your monthly payment is less than the interest that you owe on the loan, the lender will add this amount of interest to the principal. This has the effect of increasing the loan amount every single month. This is known as negative amortization. It can increase the amount of your loan significantly and eventually make it so that you cannot afford the mortgage payment. You should make sure that you can afford to pay at least the interest every month so that your loan balance does not continually increase.

Fixed-Rate Period

At the beginning of an adjustable-rate mortgage, there will usually be a certain period during which you have a fixed interest rate. For example, many adjustable mortgages will give you a fixed interest rate for the first five years of the mortgage. After that, the interest rate will reset on an annual basis depending on a financial index. You should make sure that you understand how long the fixed interest rate period is. Many people have signed up for adjustable-rate mortgages without knowing how long this fixed interest would last. You need to understand how the loan works and when the rate will start to become adjustable.

Increasing Payment

With an adjustable-rate mortgage, you really do not know how much your monthly payment is going to be in the future. Your interest rate is going to be tied to a financial index that could rise substantially from one year to the next. Some adjustable mortgages will put a cap on how much your rate can increase in one year. It would be to your advantage if you understood how these rate caps work so that you do not get a payment that you cannot afford.

If the index that is tied to your interest rate continues to increase year after year, you could potentially have a much larger payment than you started out with. In many cases, people have discovered that their mortgage payment has doubled from what it was when they initially received the loan. Not many people can afford a double mortgage payment without a substantial increase in salary at the same time. If you plan on selling the house or refinancing within a few years, an adjustable-rate mortgage could be something to look into. However, if you are going to be in the house for an extended period of time, it is a very risky proposition.