Adjustable Rate Mortgage

The term of this loan is 30 years. This loan usually has a low start rate. The length of time the start rate will remain in effect depends on the type of arm loan you choose. This low start rate is sometimes called a “teaser rate”. The interest rate your loan should actually be at is called the “fully indexed rate”.

The “fully indexed rate” is based upon two things: The margin and the index of your loan. The index is what the lender uses as a reference for what it might cost to take in money that it can then lend. There are several different indexes. If you chose an adjustable rate loan you need to understand the index that is tied to that particular loan. It is a good idea to get a copy of how a particular index has changed over the past 10 years or longer. Compare the different indexes. Some adjust quickly to market conditions. This can be a good thing if rates are going down. You would want a slower moving index if you thought that rates were going to go up. The index changes through-out your loan term.The margin is the mark-up that lenders charge to be added onto or to the index.

The margin that a lender offers you can vary. Usually a lower margin means higher points or a higher start rate but not always.

Once you lock in your loan, you are locking in the margin. It will never change during the entire term of the loan. The margin will always be added to the current index. If your start rate is 6%, your interest rate would stay at 6% until the first adjustment. If the current index is 5.36% and your margin is 2.5%, that would make the fully indexed rate 7.86%. At the first adjustment, (if the index stayed the same) your payment would adjust to the fully indexed rate of 7.86%. Even if you had a cap on the first adjustment of 2%, your rate would still increase in this instance because your new rate is below 8%. Adjustable rate mortgages usually have periodic “caps” built into the loan. The periodic caps set limits on the percentage a rate can adjust at each increase. There is also a cap for the maximum percentage that the rate can increase over the entire loan period. Pay attention to these caps because they limit your increases. Have your maximum worst case payment figured in advance. That way you know in advance what the highest payment could be. If you feel the maximum payment would hurt you financially, you shouldn’t get an adjustable loan. If market conditions stay favorable, your rate should not increase much beyond the fully indexed rate. Rates can also adjust downward in a good market.