Adjustable Rate Mortgage

• Usually fixed for a certain period of time
• Interest rate can adjust monthly
• Paymentcan adjust monthly
• Typically based on an index
• Interest only option

Adjustable rate mortgages generally have a low interest rate for in introductory period. The introductory period can vary from one month to 10 years. An adjustable rate mortgage loan is beneficial to a borrower that does not plan on staying in their home for an extended period of time because they can achieve a lower interest rate than a fixed rate mortgage. These loans are also beneficial when interest rates are generally high, a borrower can get a lower rate and refinance their home into a fixed rate when rates are lower. 3/1 ARM, 5/1 ARM and 7/1 ARM’s are the most common adjustable rate mortgages today. Many ARM’s are available with an interest only option which helps to further reduce the monthly payment, however there is no principal being paid to reduce the loan amount each month.

The interest rate is determined by adding the margin plus the index. The margin on adjustable rate mortgages will never change, the index is the only thing that changes. You will want to discuss the index with the lender so that you understand all of the details of your loan. The adjustable home loan mortgage rate can increase immediately after the initial fixed period. On a 5 year ARM the interest rate can and usually will adjust after the initial 5 years. This can be a big surprise to some home owners that do not understand this type of loan or may have forgotten that their mortgage would adjust. There are caps on the amount of adjustment. Let’s take a closer look at caps because they are very important to understand.

• Caps 5/2/5
• Caps 6/2/6
• Caps 2/2/5

These are all common caps that apply to an adjustable rate mortgage. The first number is the maximum amount of interest that the ARM can adjust immediately after the initial fixed period of the mortgage. Caps 5/2/5 means that the initial adjust can be up to 5% above the initial fixed period interest rate. If the loan is currently at 6% it could go as high as 11% on the first adjustment.

The second number in the sequence (the 2 in 5/2/5) is the maximum adjustment that adjustable rate mortgages can adjust each year after the initial adjustment. If the initial adjustment is 1%, the rate can adjust an additional 2% that year and each year after.

The third number in the sequence is the maximum that the interest rate can jump over the entire life of the loan. If the initial interest rate is 6% on an adjustable rate mortgage with 5/2/5 caps then the maximum that the interest rate will ever increase to is 11%.