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Adjustable Rate Mortgages, also known as ARMs, are loans in which the interest rate may adjust or change in the future. There are many types of ARMs to choose from and each one will adjust differently depending on the following factors:
The Term
The Index
The Margin
The Rate Caps
THE TERM
The term will determine how long the initial rate will last for. Typically program titles will tell you the adjustment terms of the program. The following are two examples of common adjustable rate programs:
Examples
5/1 ARM
A 5/1 ARM title tells you that your initial interest rate will remain fixed for the first five years (the first number) and then adjust each year there after starting in year 6 (the second number).
The 3/3 ARM
A 3/3 ARM title tells you that the initial rate will remain fixed for the first 3 years (the first number) and then adjusts every 3 years thereafter (the second number).
THE INDEX
This refers to the financial indicator that the mortgage program is tied to. Examples include T-Bills (the most common), Prime rate and the 11 District Cost of Funds (an average of various lending rates from the 11 district of California).
THE MARGIN
A fixed percent (e.g. .625%) which when added to the index determines what the interest rate will adjust to.
THE RATE CAP's
Rate caps are limitations on how much the interest rate can increase or decrease during a single adjustment and over the lifetime of the loan.
The most common interest rate caps are 2/6. This first number refers to the highest percent an interest rate can either increase or decrease per adjustment period. The second figure refers to the lifetime interest rate cap. In this example the interest rate cannot increase or decrease more than 2% per adjustment and 6% over the lifetime of the loan.
CONVERSION OPTIONS
Some ARMs contain conversion options that allow the borrower to convert from their current adjustable rate to a fixed rate with little or no costs and very little paperwork.
CONCLUSION
When comparing programs it is essential that you compare the above mentioned parts of an ARM product as they directly affect how much and how often your interest rate can change. Don't be tricked by a low start rate that saves money over the short term and costs you money over the long run.
THE BENFITS OF A ARM
* Lower interest rate.
* Lower monthly payment.
* Significant Savings over the initial fixed interest rate period.
* Easier to Qualify since the payment is lower.
THE DETRACTORS OF A ARM
* The rate may increase after the initial rate expires.
* The borrower assumes the Interest Rate risk.
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