Adjustable Rate Mortgage
An adjustable rate mortgage loan (ARM) offers lower interest rates in exchange for an adjustable rate. The loan consists of monthly payments that are based on a 30-year repayment schedule and a fixed rate for 3, 5, 7, or 10 years before the rate will adjust. After that time the interest rate (monthly payments) may change year after. This is called the adjustment period.
The new rate is based upon changes in a financial index and is calculated by adding a specified amount to the index. The amount that is added to the index is called the margin. Let’s say the index equals 4.5% at the time of adjustment and the margin equals 2.50%, the new interest rate would be 7%. However, adjustable loans usually have an adjustment cap. So if the adjustment cap is 2%, the new rate would be 6.5%.
There is also a lifetime cap which limits how much the rate can go up or down during the life of the loan. These loans can work out well for people who stay in their house for the short term or don’t intend to keep their loan for a long period of time.