7 Year ARM, 5 Year ARM, 3 Year ARM, 1 Year ARM, 7/1, 5/1, 3/1, 1/1
An adjustable rate mortgage (ARM) is a loan with an interest rate that can be adjusted at pre-set intervals. The amount of the adjustment depends on several factors outlined below. Some ARM loans have an initial period when the interest rate is fixed for a period of time 2,3,5,7,or 10 year. After the fixed period the loan converts to an adjustable rate mortgage.
Some ARM loans are adjustable during the first year with adjustable beginning after 1,3,6, or 12 months. Usually, there is a cap on the rate, which determines the highest the rate could ever go after the ARM period is over.
Adjustable Interest Mortgage (ARM) loans adjust based on the following factors:
Index: The index of an ARM is the financial medium that the loan is "attached" to, or adjusted to. The most familiar indices, or, indexes are the LIBOR (London Interbank Offered Rate), 1-Year Treasury Security, 6-Month Certificate of Deposit (CD), Prime, and COFI (the 11th District Cost of Funds). Each of these indices moves up or down based on fluctuations in the financial markets.
Margin: The margin is one of the most significant aspects of ARMs because it is added to the index to determine the interest rate that you pay. The margin added to the index is known as the fully indexed rate. As an example if the current index value is 4.250% and your loan has a margin of 2.0%, your fully indexed rate is 6.250%. Margins on loans range from 1.75% to 3.5% depending on the index and the amount of the loan.
Payment Caps: Several loans programs have payment caps as a substitute of interest rate caps. These loans programs diminish payment shock in a rising interest rate market, but can also lead to deferred interest or "negative amortization". Such loans normally cap your annual payment increases to 7.5% of the previous payment.
Interim Caps: This limits how the interest rate can be changed each time it is adjusted. The cap is usually between 1 and 2%.
Lifetime Caps: Practically all ARMs have a maximum interest rate or lifetime interest rate cap. However, the limit of lifetime cap varies within each company and different loan programs. Loans with low lifetime caps usually have higher margins.