Adjustable Rate Mortgage

An ARM is a mortgage with an interest rate that may change over time, but the initial rate is fixed for a particular amount of time, which is usually 5, 7 or 10 years. ARM holders are protected by a ceiling that limits the interest rate from rising above a certain maximum level both annually and over the life of the loan. Typically, ARM loans begin with a lower initial rate than a fixed rate mortgage, but they have the potential to rise or dip in the future.  Adjustable Rate Mortgage Loans are popular Cape Cod.  Read more about them below and check out the most recent ARM rates on Cape Cod here:

Choosing an ARM loan is a good idea when:

  • You intend to keep your home less than the fixed rate period
  • You plan to refinance to a fixed rate before the first adjustment
  • Interest rates are going down

Loan Features

ARMs have the following distinguishing features:

  • Index
  • Margin
  • Adjustment Frequency
  • Initial Interest Rate
  • Interest Rate Caps
  • Convertibility

Index

An adjustable rate mortgage interest rate increases and decreases based on publicly published indexes. ARMS are based on different indexes including:

  • United States Treasury Bills (T-bills)
  • The 11th District Cost of Funds Index (COFI)
  • London Interbank Offering Rate Index (LIBOR)
  • Certificate of Deposit Indexes (CODI)
  • 12-Month Treasury Average (MTA or MAT)
  • Cost of Savings Index (COSI)
  • Bank Prime Loan (Prime Rate)

Margin

Margin is a fixed percentage amount that is point-added to the index and are fixed for the term of the loan.

interest rate = index + margin

Adjustment Frequency

Adjustment frequency reflects how often the interest rate changes and is also known as the reset date. Most ARMs adjust yearly, but some ARMs adjust as often as once a month or as infrequently as every five years.


Initial Interest Rate

The initial interest rate is the interest rate paid until the first reset date. The initial interest rate determines your initial monthly payment, which the lender may use to qualify you for a loan. Typically, the initial interest rate is less than the sum of the current index plus the margin so your interest rate and monthly payment will probably go up on the first reset date.


Interest Rate Caps

Interest rate caps put limits on interest rates and monthly payments. Common caps include:

Initial Adjustment Cap

An initial adjustment cap limits how much the interest rate can change at the first adjustment period.

Example:

If your ARM has a 1% initial adjustment cap, your interest rate may only increase or decrease by a maximum of 1% at the first adjustment period.

Periodic Adjustment Cap

A periodic adjustment cap limits how much your interest rate can change from one adjustment period to the next. Usually a six month adjustable rate mortgage will have a one 1% periodic adjustment cap while a one year adjustable rate mortgage will have a 2% periodic adjustment cap.

Example:

If your loan has a 2% periodic adjustment cap, your interest rate may only increase or decrease by a maximum of 2% per adjustment period.

 Lifetime Cap

A lifetime cap sets the maximum and minimum interest rate that you may be charged for the life of the loan. Most ARMs have caps of 5% or 6% above the initial interest rate.

Example:

If your loan has a 6% lifetime cap, your interest rate may only increase or decrease by a maximum of 6% for the life of the loan.

Initial adjustment caps, periodic adjustment caps, and lifetime caps make up the cap structure for an adjustable rate mortgage, which are usually represented as three numbers: 1/2/6

Example:

1/2/6 — Initial adjustment cap is 1 %/Periodic cap is 2%/Lifetime cap is 6%.