Adjustable Mortgage Basics (ARMs) So what are the basics of Adjustable Mortgages? The simplest definition is that your interest rate will change, or adjust, during the term of the loan. The adjustments will either lower or higher the monthly payment typically every 6 or 12 months. Borrowers considering this option should note that certain ARMs adjust as frequently as once a month. Always read the fine print before signing by the X. Fortunately, ARMs are not subjected to the arbitrary whims of the lender; they (the rates) are attached to a specific index over which the lender has no direct influence. The life term of an ARM has two distinctions: First, the interest rate is fixed for a determined amount of time –anywhere from one month to 10 years.
Second, after the initial period of fixed interest, the rate will adjust in accordance to the specified index to which the interest rate is tied. To increase the attractiveness of this option, provisions within the loan are established to prevent the interest rate from adjusting more (or less) than 1 to 5% from the previous rate. This is a contractual cap that will vary between lenders and their agreements. The term of the loan will also have a cap that dictates how much the interest rate of the loan can rise or fall beyond the rate of the loan at inception. Two terms which are fairly easy to understand are important to you because they affect your monthly bottom line.
The first is the index. The index is a general rate that the lender uses to measure the overall interest rates trend. The second is the margin. The margin is the spread between the index and the rate that you will be charged. This is where the lender makes his or her money – how they pay “their” mortgage. The margin will vary between lenders and the index that they use. Knowing what the index means as well as the margin, you can use this formula every time the interest rate is adjusted: Index + Margin = Interest rate. The decision to acquire an adjustable rate mortgage depends upon certain factors such as the borrower’s time expectancy in the house, whether the borrower is risk tolerant or risk adverse, and the ability of the borrower to obtain a loan.