Facts About ARM's, Adjustable Rate Mortgages 

What is an ARM?

An Adjustable Rate Mortgage, called an ARM for short, is a mortgage with an interest rate that is linked to an economic index.  The interest rate, and your payments, are periodically adjusted up or down as the index fluctuates.

ARM Terminology

Index
An index ia a guide that lenders use to measure interest rate changes.  Common indexes used by lenders include the activity of one, three, and five-year Treasury securities, but there are many others.  Each ARM is linked to a specific index.

Margin
Think of the margin as the lender's markup.  It is an interest rate that represents their cost of doing business plus the profit they will make on the loan.  The margin is added to the index rate to determine your total interest rate.  It usually stays the same during the life of the loan.

Adjustment Period
The adjustment period is the period between potential interest adjustments.

       •   You may see an ARM described with figures such as 1-1, 3-1, and 5-1.

           The first figure in each set refers to the initial period of the loan, during which your 
           interest rate will be the same as it was on the day of closing.

       •   The second number is the adjustment period, showing how often adjustments can be
           made to the rate after the initial period has ended.  The examples above are all ARMs
           with annual adjustments.

If my payments can go up, why should I consider an ARM?

The initial interest rate for an ARM is lower than that of a fixed rate mortgage, where the interest rate remains the same during the life of the loan.  A lower rate means lower payments, which might help you qualify for a larger loan.

More ARM Considerations
       •   How long do you plan to own the house?  The possibility of higher rates isn't as much
            of a factor if you plan to be in the home for a relatively short time.

        •   Do you expect your income to increase?  If so, the extra funds might cover the higher
            payments that result from rate increases.

        •   Some ARMs can be converted to a fixed-rate mortgage.  However, conversion fees may
            be high enough to take away all of the savings you saw with the initial lower rate.

        •   While you can't dictate which index a lender uses, you can choose a lender based on
             the index that will apply to your loan.  Ask how each index used has performed in the
             past.  Your goal is to find a loan linked to one that has remained fairly stable.

        •    When comparing lenders, consider both the index and the margin rate being offered.

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