30/3/1
30/5/1
30/7/1
30/10/1

Example of 30/3/1:
30/3/1 ARM is a 30 year loan with a fixed interest rate and payment for the initial period of 3 years.

At the end of 3 years, the interest rate and payment changes once each year for the remaining period of the loan.

Example of 30/10/1:
30/10/1 ARM is a 30 year loan with a fixed interest rate and payment for the initial period of 10 years.

At the end of 10 years, the interest rate and payment changes once each year thereafter for the remaining period of the loan.

The 30/3/1 will have a lower initial rate than the 30/10/1. The higher the delayed adjustment period, the higher the interest rate.

There are also hybrids at:

15/3/1
15/5/1
15/7/1
15/10/1

These are the same loans with 15-year terms instead of 30 years.

Some hybrids come with longer adjustment periods.

The most common:
30/3/3
15/3/3

30/5/5
15/5/5

Example of 30/3/3:
30/3/3 ARM is a 30 year loan with a fixed interest rate and payment for the initial period of 3 years.

At the end of 3 years, the interest rate and payment changes once every 3 years for the remaining period of the loan.

Example of 15/5/5:
15/5/5 ARM is a 15 year loan with a fixed interest rate and payment for the initial period of 5 years.

At the end of 5 years, the interest rate and payment changes once every 5 years for the remaining period of the loan.

The challenge you have with this extended adjustment intervals is the timing of the interest rate market.

If interest rates shoot up at the end of your initial fixed-rate term, your adjustment rate will be set at a high rate during the period you selected. Likewise, if interest rates decline, you could set yourself in a nice interest rate position.

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1: Index:

the ARM begins with a base number which is tied to an published index that can go up or down.

Two widely used ARM indexes are the Treasury Rate Index and Cost of Funds Index.

There is more information below about these index rates and how they are determined

2: Margin:

the margin is the additional amount that the lender adds to the index to derive the Interest Rate that is charged for the loan.

The margin covers the lender's cost and profit. The margin may varies between 1.5 to 3.0 percentage points.

3: Initial Interest Rate:

the initial rate is the current prevailing rate at the time that you lock-in your position, which is generally one to three percentage points lower than the prevailing 30-year fixed loan rate.

4: New Interest rate:

the adjusted interest rate over the life of the loan. The new interest rate is calculated at the time of adjustment

• New Interest Rate = index + margin
  

 

5: Adjustment Interval:

the time between the interest rate is scheduled to change. The ARM can change every six months, annually, every three years, or every five years.

an ARM with an adjustment interval of six months is called a 6-month ARM. an ARM with an adjustment interval of 1 year is called an 1-Year ARM. and so forth

At the time of adjustment, your lender will recalculate your loan payment under the new interest rate and remaining term on the loan.

For example:
let's say that you close on 1-year ARM at 5.5% for 30 years. Your monthly payment during the first year (full 12 months) will be as follows:

 

Borrows Amount: $100,000 Interest Rate 5.5% Payment Term 30 Years (360 months)     Monthly Payments Yr-1 $567.79

At the end of one year:
your ARM will adjust and reflect the new interest rate. Your lender will then recalculate your new monthly payment using a 29-year term:

 

Borrowed Amount: $100,000.00 (less) principal paid Yr-1 $1347.09 New Borrowed Amount $98,652.91 New Interest Rate 6.0% Payment Term 29 Years (548 months)     Monthly Payments Yr-2 $598.83

6: Interest Rate Caps:

interest rate caps protect the consumer in the event that interest rates rise too rapidly.

There are lifetime caps and adjustment rate caps. Make sure your understand these caps when finalizing your loan decision.

Example Life-Time Cap: ARM index rate: 4.5% ARM margin: 2.5% Life-Time Cap: 4% Current Interest rate: 7.0% (index rate + margin) The ARM index rate has jumped to 8% The new interest rate equals 8% + 2.5% = 10.5% The life-time cap limits the new interest rate to: 4.5% + 4% = 8.5% Example Adjustment Rate Cap: ARM index rate: 4.5% ARM margin: 2.5% Periodic Adjustment Rate Cap: 1% Current Interest rate: 7.0% (index rate + margin) The ARM index rate has jumped to 6% The new interest rate equals 6% + 2.5% = 8.5% The adjustment rate cap limits the new interest rate for the adjustment period to: 4.5% + 1% = 5.5% So your new rate will be limited to: 5.5% + 2.5% = 8.0%

7: Payment Caps:

limits the payment amount the consumer needs to pay at time of interest rate adjustments.

Note:
payment caps may not provide enough payment to cover the required interest charges during rising interest rates. Under this condition, the consumer will experience negative amortization — where the interest amount not covered is added to the principal of the mortgage loan.

Example:
if your payment cap limits your monthly payment to $1050 when the true payment should be $1250 due to ARM rate adjustments, the unpaid $200 will be added to the principal mortgage loan balance for later payment.

 

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1. Lenders on the East Coast and Mid-West typically use the Treasury Rate Index:
   
   which indices are the weekly or monthly average yields on U.S. Treasury securities. These indexes reflect the state of the economy and are more volatile as they move with the market.
   
   Treasure rate index is reported by the Federal Reserve:
   www.federalreserve.gov
   
   
   
2. Lenders in the West are more likely to use the Cost of Funds Index:
   
   which is published monthly by the Federal Reserve Bank of San Francisco.
   
   11th District Cost of Funds Indices:
   www.fhlbsf.com
   

Another widely used index is the LIBOR

LIBOR (London International Bank Offering Rates) as published by the WSJ or Fannie Mae.

More information about the LIBOR index from:
www.hsh.com

You will find that about 80% of all ARMs on the market today use one of the three above indexes.

The other 20% or more ARMs may use a variety of indexes that may include CDs index, PRIME Rate, the lender's own cost of funds, and other.

Make sure you check with your lending institution on the type of index they use.

View current average index rates from www.hsn.com:
www.hsh.com
What moves interest rates:
www.hsh.com

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some lenders will entice borrowers with a teaser rate. Note that at the end of the teaser rate, lenders typically adjust the rate to the maximum amount. Make sure you calculate your monthly payment at the potential maximum rate.

Payment Recalculations:

at each adjustment period, lenders must recalculate your monthly payment at the new rate, remaining term, and existing mortgage balance after all existing payments and pre-payments made on the mortgage loan.

Lenders do make mistakes and overcharge ARM borrowers.

You should double check the banks calculation

to make sure you are not overpaying or underpaying your ARM mortgage. This requires you to calculate your new payment with the new rate (based on prevailing index and lender margin), remaining term and mortgage balance.

Download our amortization worksheet to help you in that calculation: click here

Learn about mortgage auditing services:
www.mortgagemonitor.com