Adjustable-Rate Mortgage (ARM): A mortgage loan that does not have a fixed interest rate. During the life of the loan the interest rate will change based on the index rate plus the margin, see the example below. With most ARM loans, your monthly principal and interest payment can change.
Index: the published market index used to calculate the interest rate of an ARM at the time of origination or adjustment. There are many Indexes which ARM loans may use. Two popular examples are the Treasury and LIBOR rates.
Margin: the number of percentage points the lender adds to the index rate to calculate the ARM interest rate at each adjustment.
Example: Index 2.50% + Margin 2.25% = 4.75% Adjusted Interest Rate
Adjustment Caps: Many ARM loans have adjustment caps which limited the amount an interest rate may increase at the first adjustment, subsequent adjustments or over the life of the loan. Please make sure you understand what the caps are for your ARM loan program.
Hybrid ARMs: Many Arm loans begin with a set time period of a fixed rate before the adjustments being. These are often called ‘hybrid’ ARMs. A popular hybrid ARM is the 5/1 ARM. With the loan the initial interest rate is fixed for 5 years, then it adjusts annually. Other Common hybrid ARM terms are 3/1, 7/1 and 10/1. The first number indicates the number of years the initial fixed interest rate lasts.
Interest Only: Some adjustable rate mortgage loans also offer the ability to make interest only payments for a limited time. Interest only payments can significantly lower your monthly payment but the loan will ‘recast’ in the future with accelerated principal repayments. Interest Only loans are not a good program for most consumers.