|
What is an ARM?
An ARM is an Adjustable Rate Mortgage. Unlike fixed rate mortgages that
have an interest rate that remains the same for the life of the loan,
the interest rate on an ARM will change periodically. The initial
interest rate of an ARM is lower than that of a fixed rate mortgage,
consequently, an ARM may be a good option to consider if you plan to own
your home for only a few years; you expect an increase in future
earnings; or, the prevailing interest rate for a fixed rate mortgage is
too high.
An ARM has four components: (1) an index, (2) a margin, (3) an interest
rate cap structure, and (4) an initial interest rate period. When the
initial interest rate period has expired, the new interest rate is
calculated by adding a margin to the index. Your lender will disclose
the margin at time of loan application (margins may vary from lender to
lender, so it's is a good idea to shop around for a low margin). As the
index figure moves up or down, your interest rate will be adjusted
accordingly. FHA insured ARMs use the Constant Maturity Treasury index
(weekly average yield of
U.S. Treasury securities, adjusted to a constant maturity of one
year). Increases or decreases in the interest rate will be limited by
the interest rate cap structure of your loan.
The interest rate cap structure provides some protection from large
interest rate swings. There are two types of caps: (1) annual, and (2)
life-of-the-loan. The annual cap restricts the amount your interest rate
can change, up or down, in any given year, while the life-of-the-loan
cap limits the maximum (and minimum) interest rate you can pay for as
long as you have the mortgage. FHA offers a standard 1-year ARM and four
"hybrid" ARM products. Hybrid ARMs offer an initial interest rate that
is constant for the first 3-, 5-, 7-, or 10 years. After the initial
period, the interest rate will adjust annually. Below are the different
interest rate cap structures for the various ARM products:
- 1-year ARM and 3-year hybrid ARM have annual caps of one
percentage point, and life-of-the-loan caps of five percentage points.
(Example - if your initial interest rate were 5.00%, the highest
possible interest rate would be 10.00%)
- 5-, 7-, and 10-year hybrid ARM have annual caps of two percentage
points, and life-of-the-loan caps of six percentage points.
For more information on ARMs please read HUD
Mortgagee Letters 1998-01, & 2005-14.
Return to the mortgage menu |
