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The Adjustable-Rate Mortgage: The Right Bad Credit Home Loan?

If you're exploring your bad credit home loan options and want to see what else is out there besides the traditional 30-year fixed-rate mortgage, try taking a look at an adjustable-rate mortgage.

The Advantages of the Adjustable-Rate Mortgage

An adjustable-rate mortgage, or ARM, offers many advantages to today's homeowners-- particularly for those looking for a bad credit home loan that will give them some time to get back on track. A bad credit ARM starts out with a lower introductory interest rate that typically gives you two to three years to improve your credit and refinance out (more recently these loans have become harder and may have stricter guidelines than in the past).

Unlike conventional loans for A-rated borrowers, the margin and interest rate caps are less important because the idea is to unload a bad credit loan before they ever come into play. If you can't do it, don't get an ARM for your bad credit mortgage. You need to be concentrating on fixing your finances, not opening yourself up to more problems with an unaffordable loan.

The Typical Bad Credit ARM

A couple of options offered by subprime lenders are 5/25 mortgages and 5/1 ARMs. With these loans you get a lower introductory rate for the first five years (it will be higher than the rate on a 2/28 or 3/27 but may be a safer option if you don't think you can turn your credit around in 3 years). On a 5/1, once your initial rate expires your interest rate can adjust annually. You don't generally want to be paying on a 5/1 subprime mortgage once the initial fixed period is up.

Not to be confused with a 5/1 ARM, the 5/25 loan generally offers a lower rate than the 5/1, but after the first 5 years there is a difference. There may be a balloon payment required, or your rate may be extended for 25 years at terms set by the lender. Understand the differences between these loans before selecting either one of them.

Is an ARM a Good Bad Credit Mortgage?

An ARM can be a great solution for borrowers who have a reasonable time frame for paying off the loan by refinancing or selling. Plan to get your finances in order to achieve this. Then make a back up plan in case the first one doesn't work. The number of subprime foreclosures today is evidence that depending on luck to pay your mortgage can cause you to lose your home. Your bottom line should be that if you can't get out of a subprime mortgage and into a conventional or FHA loan within five years you should probably consider putting off home ownership and get some financial counseling.

By Gabriel Traverso
Mortgage Credit Problems Columnist

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