Adjustable Rate Mortgages
Adjustable rate mortgages are geared to homeowners who want
to start with relatively low monthly payments.
Adjustable rate mortgages come with interest rates that fluctuate over the life of the loan.
For the first year or the first three years of the loan (depending on
terms), Adjustable rate mortgages begin with a relatively low interest rate tied to an index
such as the federal government's cost of funds index. That index varies
from month to month, according to economic indicators. On either the
first- or third-year anniversary (depending on the agreement), the mortgage
interest rate is reset based on fluctuations in the index.
Typically, the agreement states that at the maximum, the borrower's interest
rate can climb 2 percent in any one year and 6 percent over the length of the
loan. That maximum increase is known as the rate cap.
Because adjustable rate mortgages are usually fixed for one or three years, they appeal to owners who expect to live but a few years in their home.
Another form of adjustable rate mortgages involves the two-step mortgage, in which the loan interest rate
can be raised only once at the five- or seven-year mark.
Some borrowers might want to convert their adjustable rate mortgages to a fixed mortgage
at some point. It's best up front to ask the lender if that's possible
and if so, at what cost.