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The most common way to refer to a Adjustable Rate Mortgage is as an “ARM”. Typically an ARM has a fixed period and then an adjustment period. Generally, the initial interest rate during the Fixed Period would be lower than the prevailing interest rate on a Fixed Rate Mortgage.
This difference in rate is essentially the customer’s incentive to consider an ARM mortgage. ARMs, can help mortgage clients payment’s become more affordable due to the lower initial interest rate. The fixed period can vary from 1 month up to 10 years, and are generally referenced as a “5-1 ARM” or a “3 -1 ARM.” The first number of an ARM is how long the interest rate is fixed before the first adjustment, so for a 3-1 ARM the rate would be fixed for 3 years and then could adjust.
ARM rates adjust based on a margin above a financial Benchmark, such as the LIBOR or Treasuries, but the adjustment can be as much as 5% higher than the initial rate. So, the rate could jump from 6.5%, to 11.5% at the end of fixed period. For an example as to how that could effect someone, let’s stick with the $150,000 loan amount. At 6.5% the payment would be $948.10, but after an adjustment of 5% to 11.5%, the payment could jump to $1485.44 an increase of 537.34 per month or a percentage increase of 56%.
This potential increase is generally why clients will try to refinance their mortgage prior to the rate change, or move prior to the rate change.