If one is investing in real estate and has decided to use an adjustable-rate mortgage (ARM throughout the rest of the article), then they must be positive that they are well-prepared to push aside the lender's antics and evaluate the different loans using their own knowledge and information. In the list below, five vital tips for evaluating an ARM are mentioned along with a brief explanation of each.
1.) Check the Periodic Interest Rate Adjustment Cap - This is the nasty fellow that can cause negative amortization and the end of one's real estate endeavors. When shopping for an ARM, make sure that it has a cap on the periodic interest rate increase. Most ARMs adjust their rates every six or 12 months, but some are shorter such as monthly. Often caps of 2% are placed on the rate increase amount, but if there is no cap this means that during times of rapid rate increases, the borrower's loan payment will get completely out of control.
2.) Check Monthly Mortgage Payment Cap - This tip goes hand-in-hand with tip one. Sometimes the lender performs trickery where they will cap the monthly payment, but not the periodic interest rate adjustment. When this happens, the interest owed by the lender may cause the monthly payment to increase, yet the payment doesn't increase because the monthly mortgage payment is maxed-out at its cap. This causes the interest to then be added to the loan balance, and PRESTO....the borrower is paying interest to the lender until they die or pass the burden to their children! Payment caps are fine, but make sure the periodic interest rate increase is also capped.
3.) Lifetime Interest Rate Cap? - A good ARM will often have a cap on the amount the loan’s interest rate can travel upward throughout its lifetime. Often this is between five and seven percent over the initial (teaser) rate. This can be a life saver if one gets an ARM and interest rates continue to drive higher over the following decade.
4.) Negative Amortization - As mentioned in tip two above, avoid this nasty beast and live your life happier. If one is unsure exactly how to figure the possible rate/payment increases and is getting all confused with this math stuff, than simply go to a search engine, type in "negative amortization", and browse through the various web sites until one is found that makes since or if one has a trusted lender, they can ask them for the exact details and warning signs.
5.) Points - As with any mortgage, one must make sure that when the interest rate is quoted the points are right beside it holding hands. A point represents one percent of the loan, meaning that one point on a $100,000.00 mortgage is $1,000.00. If points are charges on a loan, they are paid up front when the loan is closed. Often people try and search for loans that require no points to paid, but there is always a trade-off. The lower a loan's points, often the higher its interest rate will be.
Remember, ARMs can be a great investment tool, but the borrower should always be well-prepared and able to breakdown the loan's attributes without relying completely on the often-times self-beneficial advice of the lender. Remember, knowledge is power!
The author is the founder and owner of both ManageYourRentals.com and LandLordDocuments.com.