Adjustable rate mortgages otherwise known as a variable rate mortgages are a mortgage loan where the interest rate on the note is periodically adjusted based on an index.
An adjustable rate mortgage (ARM) is a loan that has a fixed rate for an initial period that adjusts at the end of the initial period. Usually borrowers refinance the ARM mortgage before the interest rate resets higher.
To insure a profitable loan, the lender bases their rate on an index. Consequently, payments made by the borrower may change over time with the changing index rate.
Adjustable rate mortgages can be aquired by borrowers when unpredictable interest rates make fixed rate loans difficult to obtain. The borrower benefits if the interest rate falls and loses out if interest rates rise.
Adjustable rates transfer the interest rate risk from the lender to the borrower.
It is important to know what your "Fully Indexed" rate is in an adjustable rate mortgage. This is particularly important when your rate is about to adjust or if interest is currently accruing at the fully indexed rate. The fully indexed rate is your margin plus the adjustable rate index.
Adjustable rate mortgages are a great tool for borrowers who know ahead of time that they are only going to be in their certain home or mortgage loan for a specified period of time. If you know you are buying a home as a starter home to start your family in, but before your child enters school you will have to move to a different city with a better school district, then an adjustable rate mortgage might be perfect for you. Given the fact that your newborn will need to go to school within 5 years, a 5/1 ARM loan seems like it would be a good fit. A 5/1 ARM loan means that the rate is fixed for the first 5 years and then will adjust every year thereafter for the remainder of the loan. Another fact to think about is that the average homeowners sells or refinances roughly every 4.5 years is yet another reason that an adjustable rate mortgage could possibly be the right loan for you in certain circumstances.
When you have an adjustable mortgage there are many different indexes that your interest rate will be based off of. The most common is the LIBOR index. Some other common indexes are the MTA, COSI and COFI