Can you have peace of mind with an ARM

The worst thing about the adjustable rate mortgages (ARMs) we have in the U.S. is not that they are so dangerous but that they are so complicated. Ironically, the complications arise primarily out of efforts to make them less dangerous.

ARMs in the U.S. differ from ARMs that are the standard instrument in most other countries in three major ways:

  1. The initial period during which the rate is preset is longer. In South Africa, some banks offer "fixed-rate" mortgages, by which they mean that the initial rate can last as long as 2 years before lender discretion kicks in! In the U.S., initial rate periods run as long as 10 years.
  2. Rate adjustments are automated. Rate adjustments on ARMs in the United States are determined not by the board of directors of the lending institution but by a computer that has been programmed to apply a set of adjustment rules that are stipulated in the ARM contract. The central rule is that the rate will be adjusted on pre-specified dates to equal the value on that date of an interest rate index over which the lender has no control. The lender has zero discretion.
  3. Rate adjustments are generally constrained. The great majority of ARMs in the U.S. limit rate changes on any one adjustment date ("adjustment caps") and also set a maximum rate over the life of the instrument ("lifetime cap"). There are some that have only adjustment caps, and some with only lifetime caps, but very few have neither.

These important features of ARMs in the United States protect consumers but they also befuddle them. The educational materials on ARMs that the government requires lenders to provide to borrowers are not much help. Even those who master these materials have great difficulty bringing them to bear on the specific ARMs they are being offered. And many borrowers want to protect themselves without having to learn a lot of boring stuff for which they will have no later use.

One way to meet this problem is by using calculators 9a or 9b at www.mtgprofessor.com to determine when and by how much your future payments might rise. Peace of mind comes from knowing that you will be able to deal with the payment changes that will come from the worst scenario you can imagine.

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