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Adjustable Rate Mortgage

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Adjustable Rate Mortgage (ARM)

An adjustable rate mortgage—or ARM, as they are frequently called—has a fixed interest rate for a pre-determined period.  Following that time, the rate may change regularly every six or twelve months, and can either increase or decrease.  ARMs are tied to indexes and move up or down depending on the movement of the index.  The two indexes that Direct Mortgage uses are the LIBOR (London Interbank Offered Rate) and the Treasury (U.S. Treasury Bills) Index. 

The rate change is based on the index rate plus a margin.

ARMs have caps the limit how much a rate can change each time as well as what the maximum and minimum rates can be.  These caps reduce risk for both the borrower and the lender.

Two numbers are used in conjunction with the term “ARM” to describe how long the fixed period is and how often the rate will adjust.  The first number refers to the fixed period.  The second number refers to how often the rate can change.  For example, a 5/1 LIBOR ARM has a five year fixed period.  At the end of the five years, the mortgage’s rate resets according to the LIBOR index, and will continue to reset once every year.  A 5/6 LIBOR ARM would reset every six months.

The fixed period of an ARM could be 6 months or 1, 3, 5, 7, or 10 years.  

Adjustable rate mortgages will often have a lower interest rate during the fixed period than a comparable fixed rate mortgage will have in order to offset the risk to the borrower that the rate will increase.

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