Adjustable Rate Mortgage (ARM)
The Adjustable Rate Mortgage refers to a specific loan pricing structure where the interest rate can be subject to change at certain points over the term (usually 30 years). There are some ARM loans that have rates that adjust once a year for 30 years. This would be called a “one year ARM”. The adjusted rate is always based on a “floating index”. This index can be the fed funds rate, Prime rate, the LIBOR, or the US Treasury Bond average, are the most common indices for conforming ARM’s. (99% of conforming ARM’s are actually based on the LIBOR Index).
FHA ARM’s are usually pegged to the Treasury Average. When it comes time for the rate to adjust, the new rate is whatever that index is at the time of adjustment PLUS a fixed margin. So if you have a 5 year LIBOR ARM for instance, and the time comes for the introductory 5 year fixed rate to adjust, the new rate would be whatever the LIBOR index value is plus the fixed margin of 2.25%. So if the LIBOR is at 3.5, your new rate would be 5.75% for the next 12 months, when it would adjust again based on LIBOR plus 2.25 in the future and so on.
Most ARM’s have a fixed rate intro period. This can be for 3 years, 5 years 7 years or even 10 years. It is after this introductory fixed rate period that the loan enters the “adjustment phase” where the rate can change subject to the predetermined index and margin. The longer your fixed intro period is, generally the higher that interest rate would be. This is why 10 year ARM’s are so rare, many times the rate is so close to that of a fixed rate, you might as well get the fixed.
When a loan is in its adjustment phase, there are upper parameters that keep things slightly predictable. The upper parameter is called a “cap”. This Cap represents the highest the rate can adjust during each adjustment period, and also ARM’s have a “life cap” which represents the highest the rate could EVER be over the 30 year course of the loan.
The Adjustable Rate Mortgage or ARM structure is available for the following loan types:
- FHA ARM (3 year fixed and 5 year fixed)
- VA ARM (3 year fixed and 5 year fixed)
- Conforming ARM (1 year, 3 year fixed, 5 year fixed, 7 year fixed and 10 year fixed)
