How do Adjustable-Rate Mortgages (ARM) work?
There are many types of adjustable rate mortgages, but all have some common features. One common feature of adjustable rate mortgages is an interest rate change that occurs after a stipulated number of payments have been made. The interest rate can increase or decrease depending on how the new interest rate is calculated. Typically, the interest rate change is based upon a pre-determined index value and a margin. If a mortgagor currently has an interest rate that is pending adjustment, the new rate would be calculated by: current index + margin = new rate. The index (i.e. 1 year Treasury bill) and margin would each be set by the mortgage lender.The maximum amount the interest rate can change during any adjustment period is usually fixed. This maximum adjustment is called the cap. Adjustable rate mortgages also have a lifetime cap, preventing the interest rate from exceeding a predetermined rate.
