Adjustable Rate Mortgages are more commonly known as ARMs. An ARM is typically a 30 year mortgage with the first part of the loan having a fixed rate and the 2nd part becoming adjustable based on the market. ARMs come in 5, 7, and 10 year fixed periods before the rate can begin adjusting. ARMs traditionally have lower rates than fixed loans. These loans are a great option for borrowers who plan to stay in their home for a short period of time.
There are times when an ARM is advertised and the disclosure mentions the term of the ARM as 5/2/6. Here’s what 5/2/6 typically means…
|First 5 years is fixed and the next 25 is adjustable once per year||Maximum amount the rate can adjustments per period. So, if you start at 3%, the max it could adjust in year 6 would be to 5%. Remember this will adjust only if the Index has increased.||Maximum amount the rate can adjust over the life of the loan. The max rate you could ever see would be 3% (starting rate) + 6% = 9%.|
As with any mortgage, it is important to get these details from your licensed Loan Originator. They will be able to provide the answers to your questions and give you payment examples to help you understand your particular scenario.
It does vary, but here is the most common way. An ARM rate is comprised of two components, Index and Margin. The Index is either the LIBOR, 1 year Treasury CMT, or Cost of Funds Index (COFI). The margin is what the bank wants to make on the loan and remains constant throughout the life of the loan. So the Index (variable) + Margin (fixed) = Rate.
Most of the ARMs today adjust either once or twice a year. Some of the older loans could adjust every month! Just because a loan could adjust, doesn’t mean it will. Remember if the Index doesn’t change, then the rate won’t change.
There are maximums a rate can adjust for both the adjustment period as well as the life of the loan. This protects the borrower because there is a limit to the amount their payment can increase.