One of the financing options that are available to home buyers is the adjustable rate mortgage, which is also commonly referred to as an ARM. This type of mortgage usually starts out with an extra low interest rate. However, after the initial introductory period has expired the interest rate is adjusted based on the current prime rate. In some instances, this will make the interest rate lower. However, it usually will mean that the interest rate will be increased. The interest rate will continue to be adjusted periodically throughout the life of the mortgage. Before you apply for an ARM, it is important that you understand its basic features.

Factors That Influence the Interest Rate in Adjustable Rate Mortgages

There are many factors that influence what interest rate an ARM charges. The first factor is what index the interest rate is tied to. Most lenders use the federal index as the guide for their interest rates, but others use indexes like the 11th District Cost of Funds Index, the London Interbank Offered Rate, the 12-month Treasury Average Index, the Constant Maturity Treasury and the National Average Contract Mortgage Rate.
 
The second factor that influences the interest rate in an ARM is the set of caps that are held by the loan. Caps limit how much the interest rate in an ARM can be adjusted by during any given adjustment period. These caps typically target how often the ARM rate can be adjusted, the percentage of change the interest rate can experience during any adjustment period and the total amount of change that the interest rate can experience during the term of the loan. In addition to caps placed on interest rates, ARMs can also have caps set for mortgage payments. In this scenario a restriction will be placed on how much the monthly payment can be increased during a single adjustment period or during the term of the loan.

Types of ARMs

There are several different ARMs that you can apply for. In the traditional ARM, the interest rate will be adjusted periodically throughout the term of the loan. In a hybrid ARM, the borrower will be charged a fixed interest rate during the first segment of the loan, and then it will revert to an adjustable rate for the remainder of the loan. The final type of ARM is the Option ARM. Borrowers who select an Option ARM are given several payment options to choose from each month. They can pay a fixed rate 15 year amortized payment, a fixed rate 30 year amortized payment, a floating minimum payment or an interest only payment.