An ARM can be fixed for a period of time and then will adjust after the initial fixed period is over. There are all different types of arms. Monthly, 3/1, 5/1, 5/5, 7/1 and 10/1’s are the typical offerings. The more frequent the rate adjustments, the lower the initial rate. Here are some more common arms.

**1-Year Adjustable Rate Mortgage**

This is a 30-year loan in which the rate (and therefore your monthly payment) changes every 12 months on the anniversary of your loan. This has more risk as the rate will change yearly, good or bad.

**3-Year Adjustable Rate Mortgage**

This is a 30-year loan in which the rate (and therefore your monthly payment) changes every 3 years. This loan, while risky, is safer than the 1-Year Adjustable Rate Mortgage because it has fewer adjustments, but could get stuck at a higher rate if rates dropped after only one year of increases. You would have to wait for 2 more years for it to decrease.

**5-Year Adjustable Rate Mortgage**

This is a 30-year loan in which the rate (and therefore your monthly payment) changes every 5 years. This loan is a nice compromise between shorter term Adjustable Rate Mortgages and Fixed Rate programs, but could get stuck at a higher rate if rates dropped after only one year of increases. You would have to wait for 4 more years for it to decrease.

**3/1 Adjustable Rate Mortgage**

This 30-year loan offers a fixed interest rate for the first 3 years and then turns into a 1 Year Adjustable Rate Mortgage for the remaining 27 years of the loan. Best to refinance at no cost at the 2 year mark with another 3/1 year or 5/1.

**5/1 Adjustable Rate Mortgage**

This 30-year loan offers a fixed interest rate for the first 5 years, and then turns into a 1 Year Adjustable Rate Mortgage for the remaining 25 years of the loan. Best to look at the arm as a declining Arm. Once you have had it for 2 years you essentially only have a 3/1 left. At that point you have to start analyzing if a 3/1, 5/1 or 7/1 could make sense to refinance too with no closing cost.

**7/1 Adjustable Rate Mortgage**

This 30-year loan offers a fixed interest rate for the first 7 years and then turns into a 1 Year Adjustable Rate Mortgage for the remaining 23 years of the loan. Good products if you think you know your time lines. But analyze the optionality cost of the extra 2 years vs the 5/1.

**10/1 Adjustable Rate Mortgage**

This 30-year loan offers a fixed interest rate for the first 10 years and then turns into a 1-Year Adjustable Rate Mortgage for the remaining 20 years of the loan. Good products if you think you know your time lines. But analyze the optionality cost of the extra 5 years vs the 5/1 or 3 years vs the 7/1 arm.

Time is on your side as most teaser rates have always been lower than a fixed rate. At first meridian mortgage we have been originating No Closing Cost refinances on Arms since 1996. We have had many clients do multiple refinance from one arm to another always looking at the rate vs cost, and cost vs time.

**1. Index –** The index is the adjustable part of the arm and fluctuates with the market. Examples would be the 1-Year U.S. Treasury Bill., or the one year libor index. These are monitored and then published for use by the entity publishing the index.

**2. Margin –** the margin stays fixed for the life of the loan and is often the floor or the lowest the interest rate can go down to. This can be usually thought of as the profit for the bank.

**3. Caps –** the arm will have adjustment caps that distinguish how much the interest rate can adjust and when. It also establishes the highest interest rate possible for the life of the loan.

- Caps are usually stated in the following manner 2/2/5 or 5/2/5
- The first number is how much the interest rate can adjust the first adjustment.
- The second number is how much the interest rate can adjust per year on each adjustment.
- The third number is how much the interest rate can adjust over the life of the loan or the maximum possible interest rate.

Equation: index + margin = fully indexed rate.

When the initial fixed period is over, the interest rate will adjust based on the above formula. They will then apply the caps accordingly to see where the interest rate will be adjusted to.

**Ex. 1 Current rate 3.00% on 5 /1 with 2/2/5 caps, 2,75 margin.**

Index on 1 Year Libor Index .766 + 2.75 = 3.566

Current rate was 3.00% so you would adjust to 3.625 which is the nearest 1/8 of a percent rounded up.

**Ex. 2 Current rate 3.00% on 5 /1 with 2/2/5 caps, 2,75 margin.**

Index on 1 Year Libor Index 2.5% + 2.75% = 5.25%

In this is scenario the adjust fully index rate would be higher than the allowable adjusted rate with the cap. Ex. 3.00% + 2.00% cap = 5.00 The interest rate would adjust to 5.00 due to the caps, rather than 5.25% Fully Indexed Rate.