Adjustable Rate Mortgages or (ARM’s) are loans whose interest rate can vary during the loan’s term. These loans have a fixed interest rate for an initial period of time (usually 3, 5, 7, or 10 years) and then typically adjust on a yearly basis. The initial rate on an ARM is usually going to be lower than than what is offered with a 30 Year fixed mortgage and can be advantageous if you plan on being in your home with a timeline of one to ten years.
This lower interest rate can save you hundreds if not thousands of dollars in payments per month and over time usually performs better than a typical 30 year fixed rate mortgage. With an adjustable rate mortgage you do not have to pay for the ability to fix the rate for a full 30 years as you do with a 30 year fixed mortgage. You only pay for a fixed rate for as many years as you need it, no more.
Adjustable rate mortgages also give you the ability to make interest only payments. Interest only payments can significantly lower your monthly payment.
Adjustable rate mortgages are usually amortized over a period of 30 years with the initial rate being fixed for anywhere from 1 month to 10 years. All adjustable rate mortgages have a “margin” plus an “index”, which makes up the “fully indexed” rate. This is the end rate you pay expressed as 6.25% or whatever it turns out to be when your initial fixed period of 1 to 10 years has ended. Again, you choose how long this initial fixed period is. You make it only as long as you will need it, and therefore get a lower rate.
Margins on loans range from 1.5% to 4.5% depending on the index and the amount financed in relation to the property value, otherwise known as the “Loan to Value” of the home. The index is the financial instrument that the adjustable rate mortgage loan is tied to such as: 1-Year Treasury Security, LIBOR (London Interbank Offered Rate), Prime, 6-Month Certificate of Deposit (CD) and the 11th District Cost of Funds (COFI).