ADJUSTABLE-RATE MORTGAGES (ARM)

Adjustable-rate mortgages allow the interest rate to change at periodic intervals based on an index plus a margin (both are defined below). An adjustable-rate mortgage may also have interim, payment and lifetime caps. The loan usually has an initial interest rate and payment that is less than fixed-rate loans available at the same time. This allows for borrowers to pay less in the early years and potentially more later if prevailing interest rates rise.

Adjustable-rate mortgages can be rather complex instruments.

Here is a list of a few of the typical features:

Index: The index is the base interest rate on which the margin will be added to determine the mortgage note rate. The most common are the one-year U.S. Treasury Security, LIBOR (London Interbank Offered Rate), and the 11th District Cost of Funds (COFI).

Margin: The margin is the percentage amount that will be added to the index to determine the rate that the borrower will pay. For example, if the loan has a margin of 2.50% and the index is 5%, then the interest rate on the loan is 7.5%.

Caps: The caps limit the amount that an interest rate or payment can change on a given change date or over the life of the loan. Where prevailing market interest rates are rising, the interest rate on your adjustable-rate loan may also rise, but not as fast as market rates. The reverse is also true. Where prevailing market interest rates are falling, your rate and payment may go down, but not as rapidly. Also, there is a direct correlation between the margin and caps: usually, the lower the margin, the higher the caps, and vice versa. Adjustable-rate loan programs may differ slightly, so you should understand exactly the terms of the program you select. A lending professional will disclose all of this for you if you decide to finance with an adjustable rate product.

Some of the more common ARM programs are:

6-Month Certificate of Deposit (CD) ARM: This program allows up to one percent maximum adjustments every six months. Start rates, margins and lifetime caps vary by program.

1-Yr Treasury ARM: This program allows for a maximum two percent adjustment every twelve months. Typically, the margin is 2.5% with lifetime caps of six percent. However, the start rate, margin and lifetime caps can vary.

3-Yr Treasury ARM: This program allows for a fixed rate for the first three years and an adjustable rate for years four through thirty. The annual adjustments are limited to two percent with lifetime caps of six percent. However, each loan program can be different so be sure read and understand the disclosures.

Back to Product Selection