QandAs: Loans

What is a Fully Amortized ARM?

Answer:
Adjustable rate mortgages, or ARMs, are beneficial

for various reasons. In many instances, homebuyers choose an adjustable rate loan to lower their monthly payments. Furthermore, adjustable rate mortgages generally include a lower interest rate, which allows a borrower to buy a more expensive home.

Unfortunately, there is a downside to ARM home loans. Since the interest rate will likely fluctuate - either increase or decrease, persons who choose these types of home loans risk negative amortization. Negative amortization occurs when monthly interest payments are less than the interest due. In turn, the loan balance rises each month.

Borrowers who consider an adjustable rate mortgage should choose a fully amortized ARM. At the outset of an ARM, the interest rate remains the same for the initial three, five, seven, or ten years. In this case, the loan is fully amortized because monthly payments are sufficient to payoff the balance at termf. On the other hand, if a rate increase takes place on an ARM, and the monthly payments remain the same, the loan balance will likely rise each month and the borrower will not payoff the loan balance by the 360th month. This is an example of negative amortization. For an ARM to remain fully amortized throughout the life of the loan, monthly payments must adjust with each rate increase.


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