Reasons For ARMs
ARMs generally permit borrowers to lower their initial payments if they are willing to assume the risk of interest rate changes. In many countries, banks or similar financial institutions are the primary originators of mortgages. For banks that are funded from customer deposits, the customer deposits will typically have much shorter terms than residential mortgages. If a bank were to offer large volumes of mortgages at fixed rates but to derive most of its funding from deposits (or other short-term sources of funds), the bank would have an asset-liability mismatch: in this case, it would be running the risk that the interest income from its mortgage portfolio would be less than it needed to pay its depositors. In the United States, some argue that the savings and loan crisis was in part caused by this problem, that the savings and loans companies had short-term deposits and long-term, fixed rate mortgages, and were caught when Paul Volcker raised interest rates in the early 1980s. Therefore, banks and other financial institutions offer adjustable rate mortgages because it reduces risk and matches their sources of funding.
Banking regulators pay close attention to asset-liability mismatches to avoid such problems, and place tight restrictions on the amount of long-term fixed-rate mortgages that banks may hold (in relation to their other assets). To reduce this risk, many mortgage originators will sell many of their mortgages, particularly the mortgages with fixed rates.
For the borrower, adjustable rate mortgages may be less expensive, but at the price of bearing higher risk. Many ARMs have "teaser periods", which are relatively short initial fixed-rate periods (typically one month to one year) when the ARM bears an interest rate that is substantially below the "fully indexed" rate. The teaser period may induce some borrowers to view an ARM as more of a bargain than it really represents. A low teaser rate predisposes an ARM to sustain above-average payment increases.
Read more about this topic: Variable-rate Mortgage
Famous quotes containing the words reasons for, reasons and/or arms:
“One of the many reasons for the bewildering and tragic character of human existence is the fact that social organization is at once necessary and fatal. Men are forever creating such organizations for their own convenience and forever finding themselves the victims of their home-made monsters.”
—Aldous Huxley (1894–1963)
“Could truth perhaps be a woman who has reasons for not permitting her reasons to be seen? Could her name perhaps be—to speak Greek—Baubo?... Oh, those Greeks! They understood how to live: to do that it is necessary to stop bravely at the surface, the fold, the skin, to adore the appearance, to believe in forms, in tones, in words, in the whole Olympus of appearance! Those Greeks were superficial—out of profundity!”
—Friedrich Nietzsche (1844–1900)
“Shall the Spring dawn, and she still clad in smiles,
And with an unscathed brow,
Rest in the strong arms of her palm-crowned isles,
As fair and free as now?
We know not; in the temple of the Fates
God has inscribed her doom;
And, all untroubled in her faith, she waits
The triumph or the tomb.”
—Henry Timrod (1828–1867)