Attorney Diane Gleason shares her knowledge about Adjustable Rate Mortgages, frequently referred to as ARMs.
What is an ARM?
An ARM is an Adjustable Rate Mortgage. The interest rate is fixed for a certain period of time and then the interest rate adjusts according to the terms in the Adjustable Rate Note.
How does the interest rate adjust?
The Adjustable Rate Note identifies a fixed rate period – normally 5, 7 or 10 years. After that fixed rate period, the interest rate will adjust to a new interest rate based on an “Index” plus a “Margin.” The Adjustable Rate Note will identify how frequently the interest rate will adjust after the initial fixed rate period. The adjustment period is normally every 3 months, every 6 months, or every 12 months.
What is an Index?
An Index is a measure of change related to a particular market. Two of the most popular indexes used by lenders are (1) SOFR – Secured Overnight Financing Rate, and (2) Treasury Index. The Index can fluctuate daily depending on the a number of factors impacting the respective market.
What is a Margin?
A Margin is a number identified by the lender that will be added to the Index to determine the new interest rate at the time of adjustment.
How high can the interest rate increase?
The Adjustable Rate Note will identify the maximum interest rate. The maximum interest rate is normally – 2%, 3% or 5% over the initial interest rate.
Can the interest rate go down?
Yes – the Adjustable Rate Note will identify how low the interest rate can go (“floor”). This is normally either the value of the margin or the initial interest rate.
Why do people want an Adjustable Rate Mortgage, if the interest rate can increase?
The initial interest rate for an Adjustable Rate Mortgage is normally lower than the initial interest rate for a standard Fixed Rate loan. Also, a borrower either plans to move and sell the house before the initial fixed rate period ends or plans to refinance the loan at the end of the initial fixed rate period if the adjusted interest rate is too high.