Adjustable-rate mortgages (ARMs)1 differ from fixed-rate mortgages in that the interest rate and monthly payment move up and down as market rates fluctuate.
Most ARMs have an initial fixed-rate period during which the borrower’s rate doesn’t change. Adjustable-rate mortgages tend to be cheaper if you plan to move within seven years.
After the fixed-rate, an ARM’s rate fluctuates at the same rate as an index spelled out in closing documents. The lender finds out what the index value is, adds a margin to that figure and recalculates the borrower’s new rate and payment. The process repeats each time an adjustment date rolls around.
Most ARM rates are tied to the performance of one of the three major indexes:
- Weekly constant maturity yield on one-year Treasury Bill
The yield debt securities issued by the U.S. Treasury are paying, as tracked by the Federal Reserve Board.
- 11th District Cost of Funds Index (COFI)
The interest financial institutions in the western U.S. are paying on deposits they hold.
- London interbank offered rate (libor)
The rate most international banks are charging each other on large loans.