The Day Has Arrived
That day that you thought was far off in the future when you signed for your adjustable rate mortgage has come. Yes, it’s time for your interest rate to adjust and you don’t know what to expect. Perhaps you secured a low initial rate by going with the ARM or you planned to sell before the first adjustment. If you have a 5/1 ARM, a common type of adjustable conforming loan, you have had five short years, and now your rate will adjust annually for the rest of the term of the loan.
How Does Your Adjustment Grow?
Do you get a jolt once a year or do you get a roller coaster ride? The way your mortgage adjusts either annually or continuously once the initial fixed rate period is complete. The designations for ARMs are less organized than you might expect from the apparent format, a 5/1 adjusts annually, 5/5 adjusts every five years, but 5/6 adjusts semi-annually. A 3/27 ARM has a floating rate that changes with each payment for the 27 remaining years of the loan.
With this impending adjustment, you are transitioning from one stage of your mortgage to another. You have had a few good years at a low introductory rate, and now you will have to pay the current market rate. You have had the benefit of the bank or mortgage underwriter knowing that they have less risk of losing money on the loan over the long-term.
What Changes When An ARM Adjusts?
The interest rate formula for your adjustment comes from some published financial index, for example, the LIBOR or London Interbank Offered Rate, which is about as obscure as anyone outside the banking industry can imagine. However, this is a reliable indicator of the condition of the market and banks throughout the world use it to set rates on a variety of financial instruments.
Your ARM will also have a margin above the index that you agreed to when you applied for the loan. Regardless of the change in the index, the margin remains a constant percentage. In the initial terms of your loan, the lender defines the fixed margin and the adjustable index. When you want to get an idea of the new rate you will be paying after an adjustment, the index will be published in the financial press or on the major financial websites.
Does Your Rate Have A Cap?
Your adjustable rate mortgage most likely has at least one type of rate cap that establishes limits on interest rate changes. A lifetime cap limits the total changes in interest allowed on the loan; a periodic cap sets the limit on how much your rate can change at any one time. Some ARMs have initial caps that restrict the first adjustment more than the periodic cap. Check your loan documents to find out what the caps are on your adjustable rate.
There is always the chance that your payments reduce when they adjust; this could potentially happen every time an adjustment is due. But it is human nature that a higher payment of one or two hundred dollars is more distressing than a reduction by the same amount is pleasing.
You will likely pay less than for taking out a new fixed rate mortgage at the time your rate adjusts. If you can console yourself with that and a clear understanding of how your ARM adjustments work, you can rest a little more comfortably and enjoy the payments you are likely to make.