Adjustable Rate Mortgages

An adjustable rate mortgage or (ARM) has an interest rate that changes based on changing market rates. This kind of Pennsylvania mortgage usually offers a starting interest rate that is significantly lower than that of fixed rate mortgages, but it doesn't offer the stability or assurance of a known mortgage payment in the years to come. The interest rate on an adjustable rate mortgage is adjusted periodically based on an index that reflects changes in market interest rates. Adjustable rate mortgages have adjustment periods that determine how often the rate can change.

Adjustable rate mortgages are really not as complex as many people seem to believe. ARMs are basically broken down as follows:

Index
Margin
Adjustment period
Rate Caps

The index is what your rate correlates to. Most Adjustable Rate Mortgages are indexed to a 1-year T-Bill or LIBOR (London Inter-Bank Offered Rate) and is very similar to the federal funds rate in the U.S. The LIBOR index is released every day and it is what the banks use to lend money to one another over the short term. LIBOR is only one of many indexes used with ARMs. Other indexes might include 3-6 month T-Bills, 1-6 month LIBOR ARMs, Certificates of Deposit (CD), and the prime rate. In short, it is a daily published number used as a basis for adjusting the interest rates on Adjustable Rate Loans.

The Margin is the difference between your loan rate and the index. The lender will add approximately 2 - 2.5 percent to the indexed rate to arrive at the
"fully indexed rate" (index + margin). With some loan programs and lenders, you can buy down the margin for a fee.

Here is an Example...

The current index rate is 4%. Your margin is 2%. Your rate for your adjustable rate mortgage is (index + margin) = 6%

The Adjustment Period is the period when your ARM can adjust its rate. When the end of your adjustment period has come, your margin is added to the most up to date index to get your new rate. More often than not, your rate will not be the same and will have changed based upon the values within the index. There are many different ARM programs that will have varying adjustment periods. Common adjustment periods are 1 month, 6 month, and 1 year.

Here is an Example...

In the previous example, your "fully indexed rate" was 6%
At the end of the 1 year adjustment period, the index increases from 4% to 5%. Your margin will stay at 2%.
Your new fully indexed rate is (index + margin) = 7%

The question many people will ask right away is "What happens if the index jumps to some ridiculous number? What will happen to my rate?" Rest assured that there are measures in place to prevent such an occurrence.

A Rate Cap is a limit on how high your rate can change at the end of your adjustment period. The Rate cap protects customers from high increases in their index by limiting how much your rate can increase per adjustment period. Rate caps can vary depending on your loan program but are typically set to about 1-2 percent per adjustment period. This means that if your rate is currently 5% with a 2% Rate Cap, at the end of your adjustment period, the maximum your rate can increase to is 7%.

Here is an Example...

Index = 4%
Margin = 2%
Adjustment Period = 1 year
Rate Cap = 2%

What is the highest rate you can expect at the end of your first adjustment period?

(Index + Margin) = 6% fully indexed rate
At the end of your first adjustment period, your rate can increase to a maximum of (6% + Rate Cap) = 8%

An Adjustable rate mortgage is attractive when rates are relatively high. If rates are at all time lows, a fixed rate mortgage is more attractive. If you plan on staying in your home for a short period of time, or if you move often, than an ARM might be financially beneficial. An Adjustable Rate Mortgage gives you the benefit of starting off with a very low rate with a possibility of moving into a 15 or 30 year fixed if mortgage rates decline to all historical lows.

Call and speak with us today and one of our Loan Professionals can guide you toward the best loan option for your needs.

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