What is an Adjustable Rate Mortgage?
A type of mortgage in which the interest rate adjusts periodically according to a predetermined index and margin. The adjustment results in the mortgage payment either increasing or decreasing. A 1-year ARM, for example, will have an initial interest rate for 1 year and then adjust on the second year, and continue to adjust annually over the life of the loan. With an ARM loan, you typically get a lower starting rate in exchange for taking a risk that rates may raise in the future. There is also a cap on how much the interest rate can go up or down.
An adjustable rate mortgage is one in which the interest rate can adjust during the life of the loan. Frequently, there is an initial fixed period, ranging from a few months to several years. During this time, the interest rate remains the same. Afterwards, however, it will adjust according to the index it is tied to and the size of the margin. The margin is added to the index to create the “fully indexed” rate that you owe. This happens on the adjustment date, which can range from monthly to annually. There is also a life cap, which is the highest interest rate you could ever pay on that loan. For example, let’s say you started out with a 6.5% rate, but after five years it becomes adjustable. If the index was at 3.44 and your margin is 2.75%, your new interest rate will be 6.19% until the next time it adjusts, at which time it may rise or fall depending on the index.
An Adjustable Rate Mortgage (ARM) is just a Mortgage in which the interest rate can (and will) change at pre determined intervals. They will commonly be referred to in terms such as 5/1 or 7/1. The first of the numbers (as in 5/1) refers to the number of years that the initial start rate will remain in place before it starts to adjust. This initial start rate is also called the teased rate. Yeah, that’s teased as in we’re gonna tease the customers with this ‘low low introductory rate’ Sometimes Banking isn’t a proud industry. Anywho, the second number represents frequency of rate adjustments. Other times ARM’s can be referred to as a 2/28, 3/27, 5/25, etc. Notice that these numbers all add up to 30? In these cases the first number again represents the years of the fixed initial rate and the second represents the number of years that it will continue as an ARM. However you describe it, they all mean the same thing. So how is the rate figured out? An ARM is actual
Interest rate is fixed for the initial period, such as first three years on a 3/1 ARM. The rate then adjusts every year thereafter. On our 3/3/1 and 2/2/1, the rate is fixed for the initial period, adjusts and is fixed again for the second period and then adjusts each and every year thereafter. The new rate is based on the current Weekly Average yield of the U.S. Treasury Securities plus a margin. The rate is capped at 2% for each initial change and the lifetime cap is 6% over the initial rate. Our current margin is 2.5%. The HLPR 3/1 ARM has a cap of 1%, 5% lifetime cap and 2.75% margin.
