Types of Real Estate Loans

Adjustable Rate Mortgages

Adjustable Rate Mortgages, or ARMs are common loans in the financing of Real Property.  They allow the lender to share the risk of market fluctuations with the borrower.  In return the borrower often gets a lower rate or payment, at least initially.  These loans are best used it situations when fixed rates are relatively high, or when cash flow or short term concerns are more important than locking in a low rate for a long term.

Adjustable loans can change interest rates as often as every month, with six month and 12 month adjustments being common as well.  Usually the loans that do adjust every month do not change payment every month, and have the potential for negative amortization in the early years of the loan.  Negative amortization is what occurs when the minimum monthly payment is not sufficient to cover the interest expenses.  While this does temporarily increase the loan balance, it also allows these loans to have lower margins than comparable no- negative loans, and lower overall payments.

Negative Amortization loans  pretty much disappeared in 2008 as byproduct of the mortgage meltdown.  Cash flow optimization may still be enhanced with interest-only loans, which only require that the interest be paid each month. The interest-only period usually last 5 or 10 years, after which the loan will require both principle and interest to be paid, thus increasing the payment.

The rate of interest paid on an ARM (Adjustable Rate Mortgage) is determined by adding a margin to a predetermined economic index.  The calculations may be done periodically, or be based upon an average over a period of time.  The index and the margin are very important components of an ARM, so be sure to ask your mortgage professional about the index and the margin to be used, and how they have performed historically in the past.

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