Question

Please distinguish between the initial rate of interest and expected yield on an ARM. What is the general relationship between the two? How do they generally reflect ARM terms?

Answer 1

The fixed interest rate and Adjustable interest rate mortgage difference is that, in Fixed interest rate is set when the mortgage is availed where as in ARM, Interest rate will fluctuates depends on other factors. ie like indexes.

Usually ARM starts with lower interest rates than the fixed interest rate. The initial Interest rate will continue for some times like month, One year or few years. After the introductory period is over, Interest rate will go and down based on the market trend.

Based on the market trend, Interest rate might go down and provide the additional cash flow. This has to be calculated before going to the ARM. If only expected yield is positive, then only go for ARM or else proceed with Fixed rate mortgage.

Generally ARM Terms reflect in two numbers, like 2/28 ARM first 2 reflect fixed interest rate for 2 years and 28 reflect adjustable interest rate for next 28 years.

Usuallly ARM terms consider Cap and floor rate upto which initial interest rate might go up and down. Expected yield in ARM depending up on this cap and floor.