Adjustable rate mortgages (ARMs) are often
attractive to borrowers because they usually have lower initial interest
rates than fixed rate mortgages.
After an initial fixed period, the
interest rates of ARMs adjust up or down at a certain frequency – such
as annually – based on a couple of factors.
The first is called an
index. Adjustable rate mortgages are ‘pegged’ to some variable
financial rate, such as the one year Treasury bill.
The other factor is
a fixed amount called a margin. This runs anywhere from 2% for the best
loans, to 5% and up for loans for loans that have higher risk to the
The two numbers added together become the new adjusted interest
rate, subject to certain limitations called caps.
Adjustable rate mortgages on average tend to be
lower than fixed rate mortgages. However, when circumstances result in
the indexes rising, the result can be rates significantly higher than
when the loans closed. This of course means higher payments.
ARMs can be excellent mortgages when people expect
to have a mortgage for a certain period of time, such as when one
expects to move after a few years due to expected job transfers, changes
in family size due to births or children moving out of the home, etc.