1. Adjustable Rate Mortgage (ARM) - Variable Rate Mortgage
There is a wide choice: 1 yr ARMs, 3 yr ARMs, 5 yr ARMs, 7 yr ARMs, 10 yr ARMs. They all have one thing in common: the interest rate is fixed for a certain period at the start of the term. The fixed interest rate is 1, 3, 5, 7 or 10 years, similar to the models mentioned above. Thereafter, the interest rate can be adjusted according to market developments – in line with the respective index on which the model is based (e.g. 1 yr LIBOR / 1 yr T-Bill). The index is publicly quoted, the margin is contractually fixed, i.e. any interest rate adjustment after the first fixed term is not subject to the arbitrariness of the American bank, but is closely tied to the market.
Example: With a 3 yr ARM, interest rates can adjust for the first time after three years. To protect you as a borrower from a surprise rise in interest rates in the event of a corresponding market development, an ARM provides for a cap on the interest rate, e.g. a 2/5 cap. This means that the interest rate can adjust for the first time after three years, but only by a maximum of two percent per year and 5 percent over the entire term.
2. Fixed Rate - Fixed Rate Mortgage
Fixed-rate loans are available for 15 and 30-year terms with the same fixed interest rate. The advantage of a fixed interest rate is obvious: the borrower has a fixed interest rate at all times and knows what monthly charges to expect. However, the borrower should be aware of a possible disadvantage: Whereas with an ARM, the monthly installment will also fall in the event of early repayment, this will remain unchanged at a high level when repaying a fixed-rate loan – until the last cent has been repaid (the remaining term is reduced instead).
3. Balloon
A balloon provides for a short term (usually 2-5, in some cases also 10 years). The amortization is then designed for either 20, 25 or 30 years. Almost all balloons have a fixed interest rate. At the end of the term, the outstanding loan amount is due in full.
