A Brief Tutorial on Adjustable Rate Mortgages (ARMs) in THREE easy steps!
You typically see ARMs advertised as follows:
1/1, 3/1, 5/1, 7/1, 10/1
3/6, 5/6, 7/6, 10/6
What does this mean? In the former's case (3/1, for example), it means the loan is FIXED for the first 3 years and adjusts every 1 year after that.
In the later's case (3/6 for example), it means the loan is FIXED for the first 3 years and adjusts every 6 months after that.
What if you get into your adjustment period? How is your rate determined?
Index + Margin = New Interest Rate
Every ARM is linked to an Index at the time of origination. Some to the U.S. Treasury, some to the LIBOR. These indexes change frequently. Furthermore, every loan is given a Margin at time of origination. This margin is a FIXED number and does NOT change. Add these two together and you get your new interest rate.
All ARMs have CAPS, usually written as follows:
What does this mean? The first number is the greatest your rate can adjust at the initial adjustment. The second number is the greatest your rate can adjust at any subsequent adjustment period. The final number represents the greatest adjustment over the life of the loan.
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We will use my real life ARM as an example:
- In March 2008 I got a 3/1 ARM with 2/2/6 CAPS with an initial interest rate of 4.875%.
- My loan is due to have its first adjustment in April 2011.
- If my rate goes up at this point, it CANNOT go higher than 6.875%.
- My loan will then adjust every 12 months after that, with the second adjustment being April 2012.
- Over the life of the loan, however, my rate CANNOT go higher than 10.875%.
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I know what you're thinking! 10.875% - eegad!!!!!!! And, you're right. Outrageous!
KMG Mortgage Group