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Why is the APR for the Adjustable Rate Mortgage so high?

As required by law, Denver Mortgage Companies must assume the worst case scenario when calculating the APR for adjustable rate mortgages. In other words, we are required to calculate the APR based on the interest rate reaching it's maximum over the full 30 year term of the Colorado Mortgage. So, the APR assumes:

  1. That the borrower stays in the loan for the full 30 years (unlikely).
  2. That the interest rate will reach it's maximum (possible, if you stay in the loan beyond the fixed rate period).

Your APR is NOT your interest rate. Your interest rate is the rate at which you borrow money and pay back your loan. Interest rate (not APR) determines your payment. APR refers to the yield the lender expects to make over the life of the loan and it includes other items, such as closing costs.

Most borrowers who secure a Denver Colorado Mortgage that is adjustable, do not intend on staying in that loan for the full term. Furthermore, most borrowers intend on exiting their adjustable rate Colorado Mortgage at or prior to the first adjustment period.

However, by law, a Denver Mortgage Company is required to fully index the rate over the full term of the loan and assume the borrower stays in that loan for the full 30 years. Therefore the APR for an ARM will be higher than a fixed rate loan, and on adjustable rate Jumbo Mortgages the APR is even higher due to the increased loan size. Therefore, when calculated correctly, the APR for an adjustable rate mortgage, will be much higher than the actual interest rate.

The savvy borrow realizes that they need to get out of the ARM before it adjusts, as most Colorado Mortgage loans that are adjustable are likely to go up once the fixed period of the ARM has been reached. Therefore the APR on ARMs is somewhat misleading.

However, if for some reason a borrower was to remain in their loan beyond the fixed rate period, and they were unable to get out of the loan after the rate increase, for whatever reason, then it is possible that they could see the maximum APR. Unexpected things can happen, such as loss of job, unexpected medical expenses, identity theft, etc. All these things can lead to poor credit scores and the inability to refinance a loan.

Therefore, it's important to have an exit strategy, when securing an adjustable rate mortgage (ARM). ARMs often offer lower payments and lower rates; therefore they do offer benefits over the 30 year fixed mortgage for example, but everyone should consider the risks as well, and have an exit strategy.


 

 

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