Components of Adjustable Rate Mortgages

To understand an ARM, you must have a working knowledge of its components. Those components are:

Index: A financial indicator that rises and falls, based primarily on economic fluctuations. It is usually an indicator and is therefore the basis of all future interest adjustments on the loan. Mortgage lenders currently use a variety of indexes.

Margin: A lender's loan cost plus profit. The margin is added to the index to determine the interest rate because the index is the cost of funds and the margin is the lender's cost of doing business plus profit.

Initial Interest: The rate during the initial period of the loan, which is sometimes lower than the note rate. This initial interest may be a teaser rate, an unusually low rate to entice buyers and allow them to more readily qualify for the loan.

Note Rate: The actual interest rate charged for a particular loan program.

Adjustment Period: The interval at which the interest is scheduled to change during the life of the loan (e.g. annually).

Interest Rate Caps: Limit placed on the up-and-down movement of the interest rate, specified per period adjustment and lifetime adjustment (e.g. a cap of 2 and 6 means 2% interest increase maximum per adjustment with a 6% interest increase maximum over the life of the loan).

Negative Amortization: Occurs when a payment is insufficient to cover the interest on a loan. The shortfall amount is added back onto the principal balance.

Convertibility: The option to change from an ARM to a fixed-rate loan. A conversion fee may be charged.

Carryover: Interest rate increases in excess of the amount allowed by the caps that can be applied at later interest rate adjustments (a component that most newer ARMs are deleting).

Other Loan Programs

Adjustable Rate Mortgages (ARM)

Adjustable Rate Mortgages (ARM)s are loans whose interest rate can vary during the loan’s term. These loans usually have a fixed interest rate for an initial period of time and then can adjust based on current market conditions.

Hybrid ARMs (3/1 ARM, 5/1 ARM, 7/1 ARM, 10/1 ARM)

Hybrid ARM mortgages, also called fixed-period ARMs, combine features of both fixed-rate and adjustable-rate mortgages. A hybrid loan starts out with an interest…

Interest Only Mortgages

A mortgage is called “Interest Only” when its monthly payment does not include the repayment of principal for a certain period of time. Interest Only loans are offered on fixed rate or adjustable rate mortgages as wells as on option ARMs.

Components of Adjustable Rate Mortgages

To understand an ARM, you must have a working knowledge of its components. Those components are: Index: A financial indicator that rises and falls, based primarily on economic fluctuations.

Bank Statement Loan

Bank Statement program may help eligible self-employed borrowers purchase or refinance a home. This program uses the borrower’s business bank statements to help calculate their income without requiring tax returns.

Balloon Mortgages

A balloon mortgage has an interest rate that is fixed for an initial amount of time. At the end of the term, the remaining principal balance is due. At this time, the borrower has a choice to either refinance or pay off the remaining balance.