Adjustable rate loans have interest rates that remain fixed for a set period of time, after which they adjust periodically. These adjustments depend on the market conditions and the interest rate index to which the loan is linked. In exchange for an initial low payment and monthly payments that will change periodically thereafter, you’ll enjoy a slightly lower interest rate and monthly payment at the start, compared to a fixed rate loan. If you are looking to take out a loan which will be less than $417,000, a Conforming Loan will most likely be right for you. If you are looking to take out a loan which will be more than $417,000, a Jumbo Loan will most likely be right for you.
Conditions that may accompany the use of this loan:
- You’re comfortable with an initial low payment and monthly payments that will change periodically thereafter
- You are looking to get into your home with the lowest initial rate and payment possible
- You expect to sell your home within 3, 5, or 7 years depending on the ARM program that you choose
- You’re confident your income will rise enough in the coming years to handle any increase in payments.
How ARMs work:
- A start rate, also known as the initial interest rate, gives you a special low monthly payment for a set amount of time. Normally, 3, 5, or 7 years.
- As the start period expires, your interest rate is based on the performance of a financial index, such as the average interest rate or yield on Treasury bills, or the London Interbank Offered Rate or LIBOR.
- How often your payments are adjusted based on the index, and how much rates and payments increase at each adjustment, generally every year after expiration of the initial start rate.
- At each adjustment, the new rate is computed by adding the margin — a predetermined amount that remains the same for the life of your loan — to your financial index. Example: If the interest rate for the financial index was 5.5% and your margin 2%, then your rate at the time of adjustment would be 7.5%.
- Caps are put on the maximum amount the rate can increase. The periodic cap sets the maximum your rate can go up from one adjustment period to the next. The life cap sets the maximum interest rate for the life of the loan.
- Some ARMs offer a conversion feature that allows you to convert to a fixed rate loan at certain times during your loan.