An ARM, which is short for "adjustable rate mortgage," is a type of mortgage where the interest rate is tied to an economic index. In this type of mortgage, your payment and interest rate are changed when the index goes up or down. A fixed-rate mortgage is the opposite of an adjustable-rate mortgage. The monthly payment and interest rate on an adjustable-rate mortgage can change from time to time. If you only plan to live in the house for a short time, an adjustable-rate mortgage is the best choice because the interest rate goes down when interest rates go down.
Index, Margin, Adjustable frequency, Initial interest rate, and Interest rate caps are the most important parts of an ARM. Lenders use the Index as a guide to figure out how much interest rates have changed. The index guides that lenders use are 1, 3, and 5-year treasury securities, but there are many other index guides as well. The lender's markup is the margin that represents the cost of doing business and the profit they will make from the adjustable rate mortgage. This margin is added to the index rate to get the total interest rate, which stays the same for the life of your loan.
The reset date is when the interest rate is changed. The adjustable frequency is how often the interest rate is changed. The frequency that can be changed is different for each ARM. The adjustable frequency usually changes once a year, but it could also change once every five years or once a month. As your financial risk goes down, it's better if it changes less often. This is because your loan payment will change.
The initial interest rate is the rate of interest you would pay until your first reset date. This will determine the first payments you make on your loan, and the lender may use it to decide if you qualify for the loan. Usually, the initial interest rate is lower because your monthly payment will go up after the first reset date.
The interest rate caps limit how much your monthly payment and interest rate can go up. The most common caps are the initial adjustment caps, the periodic adjustment caps, and the lifetime adjustment caps.
You might wonder why you should get an ARM if the payments can go up. The answer is simple: the initial interest rate in an ARM is lower than in a fixed-rate mortgage and stays the same over the life of the loan. A lower interest rate means a lower loan payment, which makes it easier for you to qualify for a bigger loan.
