What Is An Adjustable-Rate Mortgage?

Simply put, an adjustable-rate mortgage (ARM) is a mortgage loan whose interest rate is initially fixed for a period of time at the beginning of the loan and then is adjusted periodically to reflect market conditions. Mortgage interest rates adjust periodically based on the mortgage index, and the payments of the borrower go up or down accordingly. Typically lenders offer lower interest rates for ARMs versus fixed mortgages. Contact a VIP loan officer at 800-680-8799 to see if an adjustable mortgage is right for you.

ARM Features | Interest-Rate Caps | Mortgage Payment Adjustment Caps

ARM Features

  • Initial interest rate. This is the beginning interest rate on an ARM. It will only be fixed for a relatively short period of time.
  • The adjustment period. This is the length of time that the interest rate or loan period on an ARM is scheduled to remain unchanged. The rate is reset at the end of this period, and the monthly loan payment is recalculated.
  • The index rate. Most lenders tie ARM interest rates changes to changes in an index rate. Lenders base ARM rates on a variety of indexes, the most common being rates on one-, three-, or five-year Treasury securities. Another common index is the national or regional average cost of funds to savings and loan associations.
  • The margin. This is the percentage points that lenders add to the index rate to determine the ARM’s interest rate.
  • Interest rate caps. These are the limits on how much the interest rate or the monthly payment can be changed at the end of each adjustment period or over the life of the loan.
  • Initial discounts. These are interest rate concessions, often used as promotional aids, offered the first year or more of a loan. They reduce the interest rate below the prevailing rate (the index plus the margin).
  • Negative amortization. This means the mortgage balance is increasing. This occurs whenever the monthly mortgage payments are not large enough to pay all the interest due on the mortgage. This may be caused when the payment cap contained in the ARM is low enough so that the principal plus interest payment is greater than the payment cap.
  • Conversion. The agreement with the lender may have a clause that allows the buyer to convert the ARM to a fixed-rate mortgage at designated times.
  • Prepayment. Some agreements may require the buyer to pay special fees or penalties if the ARM is paid off early. Prepayment terms are sometimes negotiable.

Interest-Rate Caps

Any mortgage where the borrower’s payments may increase over time comes with the added risk of financial hardships. To limit this risk, caps are a common feature of adjustable rate mortgages. Caps typically apply to three characteristics of the mortgage:

  • Frequency of the interest rate change
  • Periodic change in interest rate
  • Total change in interest rate over the life of the loan sometimes called life cap

For example, a given ARM might have the following types of interest rate adjustment caps:

  • Interest adjustments made every six months, typically 1% per adjustment, 2% total per year.
  • Interest adjustments made only once a year, typically 2% maximum.
  • The interest rate may adjust no more than 1% in a year.

Mortgage Payment Adjustment Caps

Maximum mortgage payment adjustments are typically 7.5% annually on pay-option/negative amortization loans. Speak to your VIP loan officer about what mortgage payments adjustable caps could apply to your ARM.

What Is A Fixed-Rate Loan?

A fixed-rate loan is a loan whose rate never changes over the life of the loan. Typically these rates are a higher than ARMS initially since the terms do not change for the borrower. Fixed rate loans are ideal for borrowers that want to pay the same amount on the life of their loan. There are two types of fixed-rate loans: 15-year fixed loans and 30-year fixed loans. Contact a VIP loan officer at 800-680-8799 to see if a fixed-rate loan is right for you.

A 15-year fixed loan is a home loan you pay off over 15 years at the same fixed rate payment. Offering all of the perks of the 30-year loan, the 15-year loan offers a lower interest rate and the ability to own your house outright in half the time. The lower term and lower interest rate can save you tens of thousands of dollars in total loan payments, depending on the loan amount. One drawback with a 15-year loan is that you will have a higher monthly payment. If moving is a possibility for your family in the next five years, consider if a 15-year loan is right for you.
Many Americans today opt into a 30-year fixed mortgage – a home loan you pay off for 30 years at the same, fixed rate payment. A longer repayment period versus the 15-year loan means lower payments for borrowers, and the peace of mind knowing payments will never change. One drawback of a 30-year loan is it typically has a higher interest rate compared to the 15-year loan. This is ideal for those families planning on stay in their forever home for the long term.