Final answer:
When negotiating an adjustable-rate mortgage (ARM), key terms such as the principal, amortization schedule, prepayment penalties, and escrow account are determined. Pricing an ARM means setting these terms in relation to the fluctuating interest rate. Borrowers may benefit from potentially lower rates compared to fixed-rate loans, but must understand the risks associated with interest rate adjustments.
Step-by-step explanation:
The main terms that are typically negotiated in an adjustable-rate mortgage (ARM) include the principal, the amortization schedule, prepayment penalties, and the escrow account. Pricing an ARM refers to how these terms are set relative to the interest rate which varies with market rates or inflation. A borrower may opt for an ARM to secure a lower interest rate compared to a fixed-rate loan, mainly because the ARM’s interest rate adjusts with market fluctuations, thus offering a potential cost-saving if interest rates decrease.
An ARM's interest rates are linked to a certain index or benchmark, thereby protecting the lender against potential losses due to inflation. Components like interest rate caps and adjustment intervals are important as they dictate how and when the interest rate can change. Understanding these terms is crucial for a borrower to evaluate their loan options and determine the potential risks and benefits associated with an ARM.