An adjustable rate mortgage (ARM) is an option for financing your home. Unlike a fixed-rate mortgage that will have the same interest rate locked in for its entire duration, ARMs have an initial fixed rate period at the beginning of the mortgage loan's life, but then the interest rate changes periodically after that. The most popular ARM is 5/1, where the fixed interest rate lasts for five years, then the interest rate changes every year after that.
The ARM's interest rate then fluctuates with an index rate (such as LIBOR or T-Bill yield) and the lender adds a number of agreed-upon points to that rate called the margin. The borrower agrees to this margin while the index rate is out of both parties' control.
If the index rate is 1.25% and the margin is three points when the ARM is taken out, it results in an interest rate of 4.25% in the fixed rate period. If the index fluctuates to 1.5% next year, the interest rate increases to 4.5% on the remaining principal. Monthly mortgage payments will increase and that 0.50% difference may have a drastic effect depending on the mortgage balance.
Using the same margin example of three points, if the initial index rate was 1.25% but then it falls to 1% when the fixed rate period is up then the new interest rate is 4%. Mortgage payments will decrease when the rate resets.
ARMs are ideal for homebuyers who anticipate selling shortly after the fixed-rate period is up, and smaller mortgages less likely to be adversely affected by index rate increases. For more information about ARM mortgage rates or any other questions you may have, contact the experts at Midland Mortgage today!