Adjustable-Rate Mortgages

Now that you know more about the range of options available fixed-rate mortgage options, it is time to explore the ins and outs of adjustable-rate mortgages (ARM). The primary difference between fixed-rate and adjustable-rate mortgages is that interest rates for ARM loans fluctuate over the loan's lifespan, which changes your monthly payments throughout the loan term. 

As with fixed loans, there are many ARM products to choose from.  Different ARM loans share common characteristics:

• Initial or Introductory Rates: The initial interest rate of an ARM loan. 
  Starting rates are generally 1-4% below those on conventional 30-year, fixed-rate residential mortgages. Although these low rates may allow you to qualify for a higher mortgage, remember that the interest rate may increase in the future. Borrow a reasonable amount so that you can handle the payments if the interest rate increases. 
  
• Adjustment Intervals: How often the loan’s interest rate changes throughout the term.
  Adjustment periods vary depending on which ARM product you choose, and occur throughout the loan's lifespan at regularly scheduled intervals. At the end of an adjustment period, the interest rate change takes effect.
  
  The first interest rate change will not occur until a set number of years have passed. For example, with a 3/1 ARM, the first rate change occurs after three years have passed, and will change every year thereafter for the remainder of the loan term. On a 7/1 ARM, the first rate adjustment occurs after seven years, and then on a yearly basis. Other adjustment period choices include yearly and 5/1.
  
  The mortgage contract will describe the adjustment period.  
  
• Index: Lenders use the index to determine the new interest rate on your loan for the next adjustment period.
  
  The index is a financial market indicator used by lenders to calculate the costs they incur to lend you money. Because index rates continuously rise and fall, your mortgage contract will note the date the index is calculated. 
  
  The index calculation typically occurs one to two months prior to the anniversary of the loan. How does this affect your loan’s interest rate? If the market indicates through the index that it is risky for lenders to loan money to you, you can expect a higher interest rate, or vice versa. 
  
• Adjustment Margin: This is a set percentage amount - the margin - that the lender adds to the index rate. 
  
  Lenders use this margin to help determine your ARM’s interest rate during the adjustment period. The margin amount remains constant over the life of the loan, and is between 1-3 %. The adjustment margin should be outlined in the mortgage contract.
  
  When it is time for your loan adjustment, you can “estimate” your new interest rate by adding your loan’s margin to the index rate. For example, if you have a margin of 2% and the index is set at 5.5%, you can estimate that your new interest rate will be around 7.5%.

Confused about how interest rates in ARM loans work? Don’t be.  Just remember:

1. The Index and Adjustment Margin are used to determine your interest rate. 
2. Each year, the Adjustment Interval indicates when your “new” interest rate will begin. 

And what about the Introductory Rate?  Well, it’s so low that you will probably not see this rate while you repay your mortgage.