Naturally, when applying for a home loan, borrowers prefer the loan option which amounts to the lowest monthly payment. While there are some good programs available to assist borrowers with affording a home, many programs involve future payment increases, which could be burdensome. For this reason alone, it is important for all borrowers to fully understand their loan agreement. Moreover, it is also the responsibility of the mortgage provider to ensure that borrowers are aware of all terms of the agreement.

The terms of adjustable rate mortgages ("ARMs") are tricky. In addition, each type of adjustable rate mortgage has a different guideline. For example, some ARMs may be convertible into a fixed rate mortgage within the first five years without refinancing. However, to qualify for this option, the mortgage must be a convertible adjustable rate mortgage. Other adjustable mortgages require refinancing before a fixed rate is obtained. Secondly, some adjustable rate mortgages have a fixed rate for an initial period, while others adjust annually.

A major confusion surrounding adjustable rate mortgages entails the adjustment caps. To protect borrowers from financial disaster, ARMs have interest rate ceilings, or caps. On average, the maximum cap for an adjustable rate mortgage is 2 percentage points. Therefore, the interest rate will not rise more than 2% per year.

Although the concept of the maximum cap appears to be easily understandable, some borrowers do not fully comprehend the cap. Instead of recognizing that the interest rate could possibly increase 2% each year, they mistakenly think that the cap is applied to the life of the loan. Thus, if paying a rate of 6.1%, some borrowers think that the loan rate will never rise above 8.1%. With this type of thinking, many borrowers unknowingly purchase a home that they may not be able to afford within a few years.

This common misconception can be easily avoided if mortgage providers truthfully disclose details about the adjustable rate mortgage. Moreover, providing borrowers with a schedule of loan payments or a worst-case scenario worksheet will prepare borrowers for the possibility of higher payments. This way, the borrower can make an informed decision.