ARM - Adjustable Rate Mortgage

The definition of mortgage term: Adjustable Rate Mortgage

A type of mortgage that starts with a fixed interest rate but after a designated amount of time, which can range from 1 month to more than 5 years, the interest rate is adjusted. Most ARMs are adjusted every 6 months to 1 year. The time frame between rate changes is call the adjustment period. Such mortgages often start out with lower interest rates than traditional, fixed rate, loans. Whether or not the rate changes and by how much is dependent on the index an the margin. The index is how much interest is being paid on the loan. If interest rates go up your rates will also go up. on the contrary, if interest rates go down it is possible that your rates could go down. However, not all ARMs adjust downward. Lenders most commonly base their rates on 1-year constant-maturity Treasury securities (CMT), Cost of Funds Index (COFI), or London Interbank offered Rate (LIBOR). The margin is the amount that the lender adds. Some lenders will use your credit report as a measure to influence the Margin percentage. The better your credit the less margin the lender tact's on.

There are typically interest rate caps put in place to prevent rates from getting too high. There are two types of interest rate caps, a periodic adjustment cap and a lifetime cap. The periodic adjustment cap limits the percentage that your rate can change per adjustment period. Most often this is a cap of 1-2%. The lifetime cap limits the amount that your interest rate changes over the length of the loan.

Like many things in life, not all ARMs are created equal. There are several types of ARM's. There are traditional ARMs that has a short fixed period before the first adjustment period. There are also hybrid arms that have a longer fixed period. most commonly you will see 3/1 or 5/1 ARMs. This means that the fixed period is 3 or 5 years. The 1 signifies that the rate may be adjusted only once every year. There is also an interest-only ARM. This allows you to pay only the interest for a specified number of year. After which time payments will increase regardless of interest rates. A payment-option ARM allows you to chose one of several payment options. These options include; traditional principle and interest payments, interest only payments, and minimum payments.

 

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