Adjustable Rate Mortgages (ARM)

Adjustable Rate Mortgages (ARM) loans can change during the term of the loan.  The interest rate on an ARM is usually lower in the beginning of the loan and in most cases is lower than the market condition at the time it is taken out.

A person who is making a purchase or doing a refinance can usually qualify for a higher loan amount with an ARM.  In many instances this can help a buyer purchase a more expensive home.

An ARM will combine a fixed rate mortgage with an adjustable rate loan.  Depending on the length of time the fixed rate is locked in for, when that term is up it will then adjust.  The adjustment will be based on the type of index and margin set forth in the final “note” (terms of the loan).

The ARM may start out with the interest rated locked in for 3,5,7 or 10 years before it adjusts.  Once that term is up, it will make an adjustment for the remaining years of the loan.  For example, if you had a fixed interest rate for 7 years the rate would adjust at the end of the 7 years.  From that point on it may adjust every 12 months depending on the terms of your note for the remaining 23 years.  Your payment may increase or decrease depending on the terms of your loan.

Some ARM’s are set up to adjust monthly or annually without having a fixed period of time.

When the ARM loan adjusts, the calculation on how much the adjustment will be is based on an index and margin that is in the final note.

An index that the ARM may be tied to for the adjustment may be one of the following:

  • 1-year Treasury Security
  • LIBOR (London Interbank Offered Rate)
  • Prime
  • 6-Month Certificate of Deposit (CD)
  • The 11th District Cost of Funds (COFI)

The margin is one of the most important components of the ARM loan.  A margin on a loan can range from 1.75% to 3.5%.  The lender is the one that will set the margin.

When an adjustment is made, the current index and the margin are added together and equal’s the new adjusted rate.  For example if your note indicated you had a LIBOR index and the index was 5% at the time of the adjustment and a margin of 2% they would be added together and total 7%.  Your new payment would be adjusted to that new interest rate.  There are caps on how high an adjustment could go.                  

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Deborah McNaughton

Your Mortgage Advisor for Life

President of Legacy Financial Services
Author - Radio Host - Columnist
Nationally recognized "mortgage and financial" expert
Seen on CNN, Bloomberg, Good Day NY and others

Host of the Money Manager show on KKLA 99.5FM

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