What Makes Adjustable Rate Mortgages Adjust

Adjustable rate mortgages are often fixed for varying lengths of time and then enter an adjustment period where the interest rate can fluctuate either up or down. The main components that affect the interest rate on these loans are the INDEX and the MARGIN. To understand how the INDEX, MARGIN, and terms of the loan affect the interest rate, it’s best to look at an example. The Index is always changing (ex. 6 month LIBOR) and the margin is a fixed number set by the lender.

EXAMPLE:

Index: 5%

Margin: 4%

Index: 9%

If the Index changes, your interest rate can change as well. For example, let’s say at the beginning of the year, the example we have shown above is your current interest rate. The Index is 5% and the Margin is 4%. However, one year later, the Index has increased by half of a percentage point. Your new rate, if your loan terms allow a subsequent adjustment (explained below) would be as follows:

Index: 5.5%

Margin: 4%

Index: 9.5%

The adjusted interest rate would go from 9% to 9.5% because of the change in the Index. Indexes are constantly changing and could go up or down.

Adjustable rate mortgages also have adjustment schedules and caps. If you’re considering an adjustable rate mortgage, knowing the adjustment terms is very important. A 2/2/6 adjustable rate mortgage on a 7/1 ARM (Fixed for 7 years and can adjust each year thereafter) would have the following loan characteristics:

The initial adjustment could increase your rate up to 2%

The subsequent annual adjustment could increase your rate and additional 2%

The rate adjustment cap over the entire life of the mortgage could increase over your initial interest rate by 6%

The adjustments and caps can be found in the adjustable note rate rider that should be included in your loan closing documents you sign at the title or escrow company.

Author: Matt Madlang

Matt Madlang

Find the best mortgage rates and more information about adjustable rate mortgages at BeatMyBroker.com

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