Adjustable Rate Mortgages, or ARM's, are just what they sound like, they have an interest rate that adjusts. The adjustment period varies for the type of ARM you have. Typically, interest rate adjustments are made either monthly, or semi annually, or even annually. The interest rate at the beginning of the loan is below the interest rate for a comparable fixed rate mortgage.
A very common version of the ARM is one that combines both a fixed rate mortgage component with an adjustable period. These loans typically have a fixed period at the beginning of the loan where the interest rate remains the same and then adjusts to market conditions at the end of the fixed period. Typically the fixed periods are 1, 2, 3, 5, 7, 10 years. However, the interest rate changes at specified intervals (for example, every year) depending on changing market conditions; if interest rates go up, your monthly mortgage payment will go up, too. However, if rates go down, your mortgage payment will drop also.
For the adjustments, there are some precautions that are set into place so that the adjustments don't happen too radically which could put you in a difficult financial situation.
ARMs with different indexes are available for both purchases and refinances. Choosing an ARM with an index that reacts quickly lets you take full advantage of falling interest rates. An index that lags behind the market lets you take advantage of lower rates after market rates have started to adjust upward.
The interest rate and monthly payment can change based on adjustments to the index rate.
6-Month Certificate of Deposit (CD) ARM
Has a maximum interest rate adjustment of 1% every six months. The 6-month Certificate of Deposit (CD) index is generally considered to react quickly to changes in the market.
1-Year Treasury Spot ARM
Has a maximum interest rate adjustment of 2% every 12 months. The 1-Year Treasury Spot index generally reacts more slowly than the CD index, but more quickly than the Treasury Average index.
6-Month Treasury Average ARM
Has a maximum interest rate adjustment of 1% every six months. The Treasury Average index generally reacts more slowly in fluctuating markets so adjustments in the ARM interest rate will lag behind some other market indicators.
12-Month Treasury Average ARM
Has a maximum interest rate adjustment of 2% every 12 months. The treasury Average index generally reacts more slowly in fluctuating markets so adjustments in the ARM interest rate will lag behind some other market indicators.
