Adjustable Rate Mortgage (ARM)

Adjustable rate mortgage (ARM) is a mortgage in which your payments will vary over time as compared to a fixed rate mortgage (FRM)- where   monthly payments will be steady.

There are several types of ARM loans available, with different levels of 'payment-change' risk. You can choose a loan with an interest rate that adjusts every 6 months or a year. These loans usually have the most attractive introductory rates. There are also loans that will offer a fixed interest rate for 3, 5, 7 (or even 10 years), before turning into 1 year adjustable rate loans. These loans offer some payment stability, while at the same time offering a lower rate than could be obtained with a fixed rate loan. But remember, loans with fewer rate adjustments usually charge a higher introductory rate. 

Many people choose the traditional 30 year fixed-rate mortgage loan because they want payment stability. If you only plan to stay in the home a couple of years, you may not want to pay for this security that you are not using. You may want to consider getting some type of Adjustable Rate Mortgage (ARM) loan. They offer lower starting interest rates than the 30 year fixed-rate loan. Some ARM programs will start with interest rates as low as 3%, but the interest rate will be subject to change every 3-6 months. The one year ARM loan will usually have a starting interest rate 1-2% below the prevailing 30 year fixed-rate, and will be subject to change every year. 

One of the advantages of Adjustable Rate Mortgage (ARM) loans is that they can have lower interest rates (during the first couple of years) than a fixed rate loan program. Even when fixed interest rates are low, the starting rate on ARM loans are still lower. Of course, this lower rate may be only temporary, depending on future interest rate movements. One of the questions that you need to ask yourself is: How long do you think you will live in the property? If you plan on moving in a couple of years, ARM loans can save you interest costs without exposing you to much risk of future payment changes. 

Many lenders have a variety of adjustable rate programs available that use different indexes. Most lenders use the yield on the 1 year Treasury bill, but may also use the yield on the 3 , 5, 7 & 10 year Treasury notes as the index for loans whose rates adjust less frequently. For loans that adjust more than once a year, the lender may use the LIBOR (London Interbank Offered Rate) or the COFI (Cost of Funds Index) as the index. The Cost of Funds Index is the least volatile of the indexes, so it could be advantageous in times of rising interest rates. The other indexes could work to the borrower's advantage in times of falling rates. 

Although your interest rate can be subject to change, the lender will calculate the interest rate at each adjustment period by adding its margin (an interest rate that is specified when you get the loan) to an established monetary index. The margin will vary by lender, but will usually be an interest rate of 2-3%. Most lenders use the yield on the one year T-bill as an index. For example, if at the time of adjustment the index value is 5%, and the lender's margin is 2%, your interest rate would change to 7%. Your lender will establish a maximum amount (cap) that your rate can change each adjustment period. 

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