Adjustable-rate
mortgage terms to know By Michael D. Larson • Bankrate.com
ARM definitions
If you thought the language of lending was hard
to understand, wait until you start looking at adjustable-rate
mortgages. Unlike fixed-rate loans, they have many variations
that make it tough to dissect the fine print. So you'll want
to become familiar with these terms. Bankrate.com also
offers a
full set of mortgage loan terms
ARM
Stands for adjustable-rate mortgage,
and it's any of several loans that feature a fixed rate and
payment for a period, followed by a period of variable
rates and payments.
3/1, 5/1, 7/1, 10/1, 7/23
Numerical nicknames for various ARMs.
The first number stands for the number of years in the initial
fixed period, while the second indicates how often the new adjusted
rate will remain in effect thereafter. A 3/1 ARM, for instance,
has three years of fixed payments at one rate, followed by 12-month
blocks of fixed payments interspersed with annual adjustments.
The total loan term would be 30 years.
Index
The index, or interest rate measurement,
to which your ARM will adjust. A 1-year Treasury ARM will adjust
based on the yield of the 1-year Treasury Bill, a government
debt security.
Margin
The amount of percentage points,
or spread, added to the index to come up with the rate your
ARM will charge after each adjustment. If you have a 1-year
Treasury ARM with a 2.75 percent margin, your ARM will adjust
after the first year to the Treasury Bill yield plus 2.75 percent,
or about 7.75 percent in early July.
Fully indexed rate
The rate the lender computes for
your ARM by adding its margin to the index.
Caps
The ceilings and floors put in place
for your ARM that restrict how much its interest rate can change
in a given time period. Most ARMs have an annual adjustment
cap, which limits yearly changes, and a lifetime cap, which
limits the total allowable change over the full loan term.
Prepayment penalty
This bogeyman of the industry sometimes
pops up with ARMs, so be careful. For instance, if you get a
5/1 ARM with the intention of selling the house and paying it
off in four years, make sure the lender won't charge you to
do so.
