How Adjustable Rate Mortgage Works

An Adjustable Rate mortgage is a type of home loan in which the interest rate changes throughout the life of the loan on the outstanding principal balance. In most types of adjustable rate mortgages, the initial rate of interest remains fixed for a specific period of time and after the completion of that period, it begins to reset yearly or sometimes even monthly. The adjustment of the interest rate depends upon an index plus an additional spread, known as ARM Margin.

Indexes and Margins

After the expiry of the fixed rate period, the interest rates on ARMs begin to increase or decrease as per an index plus a set margin. Most of the ARMs are tied to one of the following three indexes:

•    The maturity yield on one-year Treasury Bills
•    The 11^th District cost of funds index
•    The London Interbank Offered Rate

The index rate keeps on fluctuating, whereas the margin remains the same. For example, if the index rate is 4% and the margin is 2%, the adjusted rate of interest on the mortgage will be 6%. However, the adjustable rates of mortgage will fall to 4% if the index is 2%.

Rate Caps on ARMs

Most ARMs come with rate caps in order to protect the borrower in the scenario of drastic change in adjustable mortgage rate. There are three types of caps:

• Periodic Caps: These rate caps limit how much the interest rate can change from one year to the next year.
• Lifetime Caps: These caps limit how much the rate can increase during the term of the loan.
• Payment Caps: These caps determine how much the monthly mortgage payment can increase.

   If you still have some doubts regarding Adjustable Rate Mortgages, then feel free to call All Western Mortgage at 702-850-2790 or click here. Our expert professionals are always there by your side to solve all your queries.