Adjustable rate mortgages (often referred to as ARM’s) can expand the mortgage choices for home buyers. While this can give clients additional options to consider, it is important to realize that adjustable rate mortgage options can have fluctuations in interest rate which can impact your overall cost to borrow.
ARM’s work best for clients who are expecting to keep their mortgage for a shorter period of time. This may be the case for clients who anticipate life changes that would result in paying the mortgage off sooner. Changes such as a job relocation, change in family status or financial position are common reasons clients may consider an ARM. ARM’s can also benefit clients who are anticipating a decrease in interest rates. With that being said, it is important to recognize that nobody can predict the future of interest rates and betting on lower interest rates comes with potential risk.
Typical adjustable rate mortgages are repaid over a 30 year term with rate changes that can fluctuate depending on the option you select.
Common Adjustable Rate Types
1/6 Adjustable Rate
This adjustable rate mortgage has an interest rate that is fixed for the first 12 months. After 12 months your rate will change once each 6 months until your loan is paid in full.
3/6 Adjustable Rate
This adjustable rate mortgage has an interest rate that is fixed for the first 3 years. After 3 years your rate will change once each 6 months until your loan is paid in full.
5/6 Adjustable Rate
This adjustable rate mortgage has an interest rate that is fixed for the first 5 years. After 5 years your rate will change once each 6 months until your loan is paid in full.
7/6 Adjustable Rate
This adjustable rate mortgage has an interest rate that is fixed for the first 7 years. After 7 years your rate will change once each 6 months until your loan is paid in full.
10/6 Adjustable Rate
This adjustable rate mortgage has an interest rate that is fixed for the first 10 years. After 10 years your rate will change once each 6 months until your loan is paid in full.
Understanding How Your Interest Rate Changes are Calculated:
It is important to understand how future interest rate changes are calculated. Interest rate changes are impacted by the following factors:
Index – This is the base rate that is used in the calculation of your interest rate. Recently the most common index was the 1yr LIBOR. With recent changes in regulations this index is expected to be replaced by the SOFR (Federal Reserve Bank of New York’s Secured Overnight Finance Rate).
Margin – When determining the interest rate, the margin is added to the index to determine what your interest rate will change to. In most cases, the sum of the index and margin are rounded to the nearest 1/8th percent.
Initial Interest Rate Change Cap – This is the maximum amount your interest rate can change to on the very first interest rate change.
Subsequent Interest Rate Change Cap – This is the maximum your interest rate can change on any subsequent interest rate change.
Lifetime Interest Rate Change Cap – This is used to determine the lifetime maximum interest rate your loan can every have.
Floor Rate – This is the lowest rate your mortgage can ever go to.
Ceiling Rate – This is the maximum interest rate your mortgage can ever go to.
Look back Period – This is the number of days prior to any interest rate change that your lender looks back to determine the index rate used for your interest rate change.
The responsible use of adjustable rate mortgages can benefit consumers as long as they understand the risk associated with these products. It is very important that you review the specific terms of your adjustable rate options as the specifics can vary significantly from program to program.