If you are refinancing your home loan and are considering an Adjustable Rate Mortgage there are a number of things that can go wrong. Doing your homework before refinancing will help you recognize and avoid these pitfalls. Here are several tips to help you avoid paying too much when refinancing with an Adjustable Rate Mortgage loan.

Adjustable Rate Mortgages (also known as ARM loans) became popular in early 80s. These loans featured lower interest rates than traditional mortgages and easier qualification. The problem with adjustable Rate Mortgages is that many homeowners use these loans to purchase homes they cannot afford with traditional fixed rate mortgage loans.

As the name implies, the interest rate changes over time; your lender adjusts the loan at regular intervals to the index your loan is tied plus their margin. Margin is the markup your lender adds to cover their “expenses.” The index your loan is tied to varies from one lender to the next and there is no one “ideal” index. Your loan may be tied to the Treasury Bill Index or even the London Inter-Bank Offered Rate or LIBOR index. The LIBOR index is popular with mortgage lenders that sell their loans to European investors.

Adjustable Rate Mortgage Safety Features

There are safety features available to homeowners that choose this riskier variety of mortgage loan. These features are known as “caps” and limit how much the lender can raise your interest rate or payment amount during any adjustment period. It is important to structure the caps on your loan properly; homeowners who neglect choosing both periodic and payment caps can experience negative amortization with their loans. Mortgage loans that are negatively amortized actually grow over time.

Adjustable Rate Mortgage Benefits

Depending on the economy and the going interest rate, the introductory offer of your Adjustable Rate Mortgage could save you a lot of money. This introductory rate, often called a “teaser rate” is usually much lower than fixed rate loans. It is important to understand that this introductory rate is not your contract rate; at the end of the introductory period the lender will adjust the loan and your payment will go up.

You can learn more about the risks of mortgage refinancing with an adjustable rate loan by registering for a free mortgage tutorial.