What is an Adjustable Rate?
An Adjustable Rate Mortgage provides a specific fixed rate term before becoming an adjustable mortgage. An example: A 10/1 ARM is fixed for the first 10 years and then becomes a 1 year adjustable rate for the remaining term of the mortgage, thus giving you 10 years of security at a fixed rate.
Advantages: If you know that you are selling your home in a short period of time, 10-12 years or less, you can get a mortgage rate that is 3/4’s to 1 full percent below the traditional mortgage rates. Today a 10 year ARM is 5.00% and you can borrower up to 2 Million Dollars.
How do they work?
Adjustable Rate Mortgages (ARM’s) come in many different varieties. The most common ARM’s are the following: Three Year, Five Year, Seven Year and a Ten Year. You will also see them displayed in this format as well: 3/1, 5/1, 7/1 and 10/1. The first number represents the amount of years the loan will be fixed for and will not change from its original start rate. The higher the first number or term, the higher the interest rate will be.
The second number represents how often the ARM will adjust after the fixed rate term ends. Using a 5/1 ARM as the example, when your fixed term is about to expire, the Lender will send you a notice via mail notifying you that your rate is about to adjust and what that adjustment will be. This will occur 45 days prior to this expiration date, in this case that would be 60 months in to this loan (5 Years). The new rate will be set for one year, or the term that is stated in the second number, 5/1.
The adjustments are based on 2 variables, the index and the margin. The margin is set on the day you get the mortgage and is usually in the range of 2.25 or 2.75 depending upon the type of ARM you go with. This will never change and is set for the life of the loan. We would then add the current Index to this margin and combined that would create your new rate.
The Index can come from many places but is selected when we lock in your loan. Typically we use the One Year Treasury Bill or the One Year LIBOR. Both indexes move fairly slowly. These Indexes are always posted in the Wall Street Journal but is very easy just to Google these terms. This will show you the current rate as well as show the history of these rates. You can also click this site at the US Treasury
Today’s one year treasury is at 4.00 (9/16/2022), this is the index. Add this to the margin of 2.50 and your new rate today would be 6.50%. This is know as the Fully Indexed Rate. This rate would be rounded up to the next highest/nearest 1/8th in the case the T-Bill was not an even number. Remember, this is what the rate would adjust to after the fixed term has ended.
Caps: Your loan comes with caps of 5/2/5, each number represents how your loan will adjust. With the first adjustment the loan can adjust 5% up or down from the original start rate. The second number “2” is what it can adjust each time for the remaining years of the loan. So, the second adjustment and every one after that the rate can move up or down a maximum of 2%. The last number is the Life Cap. This rate will never go higher than 5% of the starting rate. So if you lock in a rate of 5.00% today, your rate would never exceed 10.00%. To give you an idea, since 1996, this rate has not exceeded 8.25% at its high point. In the last several years, this rate as adjusted downward and as low as 2.00% in many cases.
I hope this is helpful. Always feel free to ask questions about any of this information. Email me at Bill@billnickerson.com or call 978-273-3227.
Thank you very much,
Bill Nickerson NMLS# 4194 | Mortgage Equity Partners| Lynnfield MA
The Mortgage Markets 