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What is an adjustable rate mortgage?

An adjustable rate mortgage — commonly known as ARM — come in 5, 7, and 10-year fixed periods before the rate can begin adjusting and traditionally have lower rates than fixed loans. ARM loans make a great option for borrowers who plan to stay in their home for a short period of time.

You may also see times when an ARM is advertised and the disclosure mentions the term as 5/2/6. Here’s what this typically means:

5
years

  • The first 5 years is fixed and the next 25 is adjustable once per year.

2%

  • Maximum amount the rate can adjust per period. If you start at 3%
  • the maximum it could adjust in a 6 year would be 5%. Remember
  • this will only adjust if the index has increased.

6%

  • Maximum amount the rate can adjust over the life of the loan. The maximum rate you could ever see would be 3% (starting rate) + 6%
  • equalling 9%.

How does the rate adjust with an ARM?

ARM’s do vary, but the most common way 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 laon and remains constant throughout the life of the loan. So the Index (variable) + Margin (fixed) = Rate.  

How often does an ARM rate adjust?

Most of the ARMs today adjust either once or twice a year. Some 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.

How much can it adjust?

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.

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