Adjustable Rate Mortgages (ARMs)
What is an Adjustable Interest Rate Mortgage (ARM)?
The adjustable rate mortgage is a mortgage loan with an interest rate
that adjusts at set intervals. The frequency at which the
adjustable rate mortgage adjusts, depends on the borrowers choice during
financing.
There are many different adjustable rate mortgage products available
with 3/1, 5/1, 7/1 being the most common. The first number in loan
program is for how many years the interest rate remains fixed. The
second number is for how often the rate will adjust after the fixed
period ends.
Limitations known as caps are commonly used to limit the risk
borrowers take when choosing adjustable rate mortgages. Caps such
as 5/2/6 on a typical 3/1 arm apply as follows:
- The "5" shows the interest rate can adjust up or down a maximum
of 5% after the initial 3 year fixed rate period ends.
- The "2" shows the interest rate can move up or down a maximum of
2% on subsequent annual adjustments.
- The "6" shows the interest rate cannot move more than 6% above
or below the initial fixed rate over the life of the loan.
When shopping for an adjustable rate mortgage you'll have a
choice between a fully amortized or interest only adjustable rate
mortgage. Fully amortized means you must pay principal and
interest payments, while interest only means you have the choice to
make interest payments
or you can choose to make principal and interest payments.
- Initial - The "5" shows the interest rate can adjust up
or down a maximum of 5% after the initial 3 year fixed rate period
ends.
- Periodic - The "2" shows the interest rate can move up or
down a maximum of 2% on subsequent annual adjustments.
- Lifetime - The "6" shows the interest rate cannot move
more than 6% above or below the initial fixed rate.
Looking through loan documents should shed light on which index
(LIBOR, COFI, MTA, T-BILL, CMT, etc.) your loan is tied to and what
margin you agreed to, knowingly or not. Check the local paper for
your index and add the margin, that's your current interest rate.
| Margin |
| + |
| Index = New interest rate |
If the loan officer can saddle you with a large margin, then
you're going to have a higher interest rate after the first
adjustment. Not to mention he'll be pulling a larger profit on
the loan.
Adjustable rate mortgages are great products when used properly.
When shopping for one make sure it's going to fit your particular
situation as all adjustable rate mortgages will carry more risk than a
fixed rate product.