subject: How Do Adjustable Rate Mortgages Adjust? [print this page] If you are considering purchasing a property or refinancing your existing home loan and you only plan on being in your residence for less than seven to ten years, then it may make sense to consider an adjustable rate mortgage. Commonly known as ARMs, adjustable rate mortgages have introductory rates which are in place for a set number of years before then adjusting up or down based upon the movements of an interest rate index which the loans are tied too. Common indexes which adjustable rate mortgages use include the 1 Year Treasury Rate and the 1 Year LIBOR (aka the London Interbank Offered Rate).
When shopping for adjustable rate loans, home buyers and home owners should make sure that they have a solid understanding of the loans' margins, associated indexes, adjustable intervals, and the caps for the adjustments. Consumers should also be aware that the first adjustment (after the introductory period ends) may be greater than that of future adjustments.
For example:
A loan officer quotes a 3/1 LIBOR ARM with a start rate of 3.250% and a 2.500% margin and a initial rate cap of 3% and then annual rate caps of 2% for every year thereafter. In this scenario the intro note rate would be set at 3.250% for the first three years of the loan. On the 37th month, the loan would adjust by adding the loan's margin (2.500%) to the current index rate (say 1.000%). The result would be the "fully indexed rate" of 3.500%. In this scenario a person would actually see their note rate go up only .250% (3.250% to 3.500%) for the first adjustment.
Should One Consider an ARM?
ARMs do carry added layers of risk and it is up to consumers to determine whether the rewards outweigh the potential risks. The initial step is to examine how much lower current adjustable mortgage rates are than fixed interest rates and determine how much savings there may be in the introductory rate period. Unless the ARM rates and savings are extremely attractive, the consumer may want to play it safe with a fixed rate mortgage program. Adjustable rate mortgage borrowers should also feel confident in their ability to refinance before their loan's first adjustment and that the real estate values in their communities are in a stable or appreciating environment. The last thing a home owner wants is to be upside down on their home loan and stuck in an ARM without the ability to refinance.
