Adjustable Rate Mortgages or “ARM‘s” are an alternative to Fixed Rate Home Loans. While many consumers prefer the security Fixed Rate Mortgage provide, ARM’s offer a way to reduce your home loan interest rate.
Fixed Rate Vs. Adjustable Rate Mortgage (ARM)
Fixed Rate Mortgage interest rates remain the same for your entire loan. Regardless of the term, your interest rate never changes on a Fixed Rate Mortgage.
In contrast, Adjustable Rate Mortgage rates may fluctuate after a pre-determined period of time. An ARM’s rate may increase OR decrease impacting your monthly home loan payment.
ARMs and Their Adjusting Rates
Predetermined terms dictate when and by how much an ARM’s rate adjusts. For example, the following time-frames impact ARM rates.
Fixed Period: Initial time period when interest rate is fixed
Period: Time period in between interest rate changes after Fixed Period has passed
Decoding both time-frames is simple. Lender’s describe ARMS in the following format: Fixed Period / Period.
For example, a “7/1 ARM” has a 7 year Fixed Period meaning its rate is fixed for the first 7 years. A 7/1 ARM also has a 1 year Period. In other words, after 7 years this ARM’s rate can adjust 1 time per year.
How Rates Move on Adjustable Rate Mortgages (ARMs)
ARM rates are based on an index. Lenders then add a “Margin” to the index when determining an ARM’s rate. For example, an index of 2 and a Margin of 1.5 mean the ARM’s initial rate is 3.5% (index + margin).
After the Fixed Period, ARM rates adjust with it’s index’s. For example, the rate on ARM’s with the 12 Month LIBOR as the index rise and fall along with the 12 Month LIBOR. ARM rate changes are limited by “Caps” and “Floors”.
Caps Limit ARM Rate Increases
Adjustable Rate Mortgages interest rates only move as high as their pre-set CAPS allow. CAPS come in 3 varieties and each ARM loan typically has one of each.
- Initial CAP: Limits amount an ARM’s rate rises immediately after the Fixed Period
- Periodic CAP: Restricts how much an ARM’s rate changes each Period
- Lifetime CAP: Limits amount an ARM’s rate rises over the term of the loan