Problems With an ARM Mortgage

An ARM is just one type of mortgage.mortgage image by hans slegers from Fotolia.com

Many borrowers shy away from adjustable-rate mortgages, known as ARMs, due to the fact that the interest rate is not fixed. This variance in interest rate can cause a myriad of financial issues for a borrower. Many borrowers opt for an ARM to take advantage of the lower initial interest rate and then find that the interest rate adjustments are too much to handle.

Variable Interest

In most cases, an ARM has a lower initial interest rate than a fixed-rate mortgage option. Many borrowers find this attractive and assume they will simply refinance to another rate once the lower initial period ends. However, the interest rate can increase or decrease during the life of the mortgage. There are preset time periods at which the rate will adjust. It can rise or fall depending upon the interest rates at the time of the adjustment. This can dramatically increase or decrease the amount of interest paid over the life of the mortgage. If a borrower purchased the ARM during exceptionally low interest rates, odds are that the rate will only increase over the life of the debt.

With the variance in interest rate comes a variance in monthly payment. As the interest rate increases, so does the monthly payment. Additionally, the percentage of the principle that is being paid down each month decreases as the interest paid each month increases, causing the term of the mortgage to shift to a longer rate note.

With each ARM, there is a cap and a floor on the interest rate. This floor is as low as the monthly payment can go, regardless of current interest rates in the market. The cap is as high as the monthly mortgage payment can go, regardless of how high the current mortgage interest rates are at the time. Therefore, if the interest rate rises higher than the cap payment allows, the borrower might not be paying the total interest that has accrued each month. If this is the case, the unpaid interest is added to the debt, and the principle owed is increased. This is known as a negative amortization loan.