How Interest Rates Can Change For Adjustable Rate Mortgage (ARM) Loans

If you are in an adjustable rate mortgage (ARM) loan or are considering getting one you need to know what your risks and protections are.

The interest rate on an adjustable rate mortgage can change in many different ways.

Interest Rate Adjustments

An adjustable interest rate is based on:

• the lender's margin

• the index value

• the lifetime loan cap

• rate adjustment cap

• rate change interval

• rate floor

The lender margin

The lender's margin is the lender's profit, built on top of the cost of borrowing money for them.

Index value

The cost of the money in theory is the index. This index is usually based on a third-party index such as the LIBOR index. The index is a publicly available index that is not determined by the bank but by other parties. This keeps the bank from arbitrarily changing the index. The indexes are often common between different banks because they represent different interest rate indexes. The monthly payment is usually the index plus the margin.

The lifetime loan cap is the maximum interest rate allowed on the loan ever. This can be an absolute cap, meaning that even if the index skyrockets the interest rate payment does not. This is protection for the borrower.

An increasing adjustment cap is the maximum change in interest rate at any one time

A rate change interval is the time frame that the interest rate remains the same and changes at the end of the period. For example, a 6 month period means that the interest rate changes only once every 6 months.

An interest rate floor is the minimum interest rate on the loan. This protects the lender in case interest rates become very low.