How Does my Adjustable Rate Mortgage (ARM) adjust?

"There are many moving parts to an Adjustable Rate Mortgage (ARM) but here at Spire Financial, we've got you covered. Below we'll break them down, so lets dive right in.

• Start Rate
• Index
• Margin
• Caps

Start Rate
This is the rate you have for the starting fixed term of your loan. If you get a 5 yr ARM at 4.5% for example, your payments for the first 5 years are always going to be the same based on your rate of 4.5%. Once the starting fixed term is over, this will start to adjust.

Index
This is the agreed upon indicator of what your rate will adjust with. Some commonly used indexes that lenders use are the LIBOR, 10 yr Treasury and the 10 yr MTA. The most common being the LIBOR (London InterBank Offered Rate). You can read more about the LIBOR index here.

Margin
The margin is the amount that the bank adds to the index to come up with your rate. Typically this is around 2.25%. The bank sets this margin based on how much they want to make in interest on your loan above what the index is. They understand that if the index goes low or close to zero that they are still going to make at least the margin in interest on your loan. It's the minimum amount they are willing to charge you on your interest rate. Remember, loan interest = bank profit.

Caps
Caps are a VERY important part to this whole equation. There are typically 3 caps outlined for each loan product. The are denoted like this: 2/2/5.

The first cap listed (in this case the first 2) shows the max percentage that your rate can move the FIRST time your rate is up for an adjustment (most ARMs adjust every 6 months or once a year).

The second cap (in this case the second 2) shows the max your rate can adjust in an adjustment period excluding the first period.

The third cap (in this case the 5) is the max your rate can increase from your initial start rate. For example, if your initial start rate when you signed the loan was 5%, the max your loan could ever go to regardless of what the LIBOR was at is 10%. For this reason, it is very important to know your caps.

Putting it all together. a quick example
Start rate = 5%
Index = "LIBOR" - this is the moving part.
Margin = 2.25%
Caps = 2/2/4

On the First adjustment day of your loan the LIBOR is at 5%.

Index + Margin = Rate
so:
5% + 2.25% = 7.25%

However, since our FIRST cap is 2, our first adjustment is maxed out at 5% (start rate) + 2% cap = 7%. This is our new rate after adjustment one.

On the Second adjustment day of your loan the LIBOR is at 5.25%.

Index + Margin = Rate
so:
5.25% + 2.25% = 7.5%

Since this rate didn't increase more than 2 percentage points from the previous rate of 7%, this is our new rate.

NOTE: Never could this rate go above 10% (5%+5%). Also, if the LIBOR drops, which is happening right now, your rate could potentially go down!


If you have any more questions on this please feel free to call any of our loan officers as they would be glad to assist you in understanding the ins and outs of the adjustable rate mortgage.