Adjustable Rate Mortgages or (ARMs) are loans with an interest rate that can vary during its 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 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.
Typically amortized over a period of 30 years, the initial rate is fixed for anywhere from three to ten years. All ARMs have a “margin” plus an “index”, that makes up the “full indexed” rate. This is the end rate you pay, expressed as a percentage when your initial fixed period of three to ten years has ended. You choose how long the initial fixed period will be, making it only as long as you will need the 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, and are otherwise known as the “Loan to Value” of the home. The index is the financial instrument that the adjustable rate mortgage is tied to. Example: 1-Year Treasury Security, LIBOR (London Interbank Offered Rate), Prime, 6-Month Certificate of Deposit (CD), and the 11th District Cost of Funds (COFI).