Adjustable-Rate Mortgages (ARMs)
Basic Features
ARM: Adjustment Period
With most adjustable-rate mortgages (ARMs), the interest rate
and monthly payment change every year, every three years, or every
five years. However, some ARMs have more frequent rate and payment
changes. The period between one rate change and the next is called
the "adjustment period." A loan with an adjustment period
of one year is called a one-year ARM, and the interest rate can
change once every year.
ARM: Index
Most lenders tie ARM interest-rate changes to changes in an "index
rate." These indexes usually go up and down with the general
movement of interest rates. If the index rate moves up, so does
your mortgage rate in most circumstances, and you will probably
have to make higher monthly payments. On the other hand, if the
index rate goes down, your monthly payment may go down.
Lenders base ARM rates on a variety of indexes. Among the most
common indexes are the rates on one-, three-, or five-year Treasury
securities. Another common index is the national or regional average
cost of funds to savings and loan associations. A few lenders
use their own cost of funds as an index, which gives them more
control than using other indexes. You should ask what index will
be used and how often it changes. Also ask how it has fluctuated
in the past and where it is published.
ARM: Margin
To determine the interest rate on an ARM, lenders add to the
index rate a few percentage points, called the "margin."
The amount of the margin may differ from one lender to another,
but it is usually constant over the life of the loan.
Index rate + margin = ARM interest rate
For example, let us assume that you are comparing ARMs offered
by two different lenders. Both ARMs are for 30 years and have
a loan amount of $65,000. (Note that the payment amounts shown
here do not include taxes, insurance, or similar items.)
Both lenders use the rate on one-year Treasury securities as
the index. But the first lender uses a 2% margin, and the second
lender uses a 3% margin. Here is how that difference in the margin
would affect your initial monthly payment.
|
Home sale price |
$ 85.000 |
|
Less down payment |
- $ 20.000 |
|
Mortgage amount |
= $ 65.000 |
|
Mortgage term 30 years |
|
|
|
First Lender |
|
One-year index = 8% |
|
Margin = 2% |
|
ARM interest rate = 10% |
|
Monthly payment @ 10% = |
$ 570.42 |
|
|
|
Second Lender |
|
One-year index = 8% |
|
Margin = 3% |
|
ARM interest rate = 11% |
|
Monthly payment @ 11% |
$ 619.01 |
In comparing ARMs, look at both the index and margin for each
program. Some indexes have higher values, but they are usually
used with lower margins. Be sure to discuss the margin with your
lender.
The information provided in this website is
not legal advice and should not be interpreted as legal advice.
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information in summary form. This information may not be comprehensive,
is subject to change, and may not apply to all individual circumstances.
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