With an adjustable rate, both the interest rate and the mortgage payment vary, based on market conditions.
Under normal conditions, the initial interest rates are fixed for a specific period of time, after which it is readjusted on a monthly or annual basis.
Adjustable Mortgages rates (ARMs)are composed of the following features:
- Initial interest rate. The predefined interest rate at the beginning of the mortgage.
- The adjustment period. The length of time during which the mortgage is scheduled to remain unchanged.
- The index rate. The changes in an Adjustable Mortgage rate are tied to a set of indices, such as Treasury securities, national averages costs of funds, and loan associations.
- The margin. Adding a margin to the index rate determines the ARM interest rate.
- Interest rate caps. Interest rate caps limit how much the rates can change at the end of each adjustable period.
- Conversion. In some ARM mortgages, a clause is added which allows the buyer to negotiate with the lenders, in order to convert the mortgage to a fixed rate mortgage.
- Prepayment terms. In some cases, the buyer will be required to pay a penalty if the ARM is paid off too early. These terms can be negotiated in some cases.