How an Adjustable Rate Mortgage Works

The interest rate on your adjustable rate mortgage (ARM) changes (called an Adjustment) according to an index. The index is based on a macro-economical indicator. Your rate will usually be a few points above that index (margin.) The most commonly used index is the 1-Year U.S. Treasury Bill.

Your lender doesn’t have any control over the index but it has control on how much of a margin it wants to have. The lender can also choose how often the rate will change, and when it becomes and adjustable rate. Usually, the more frequent the rate adjustments through the life of the loan, the lower the initial rate

All adjustable rate mortgages have a lifetime rate cap (ceiling), which sets a limit on the amount the rate can increase during the life of the loan. Most ARMs also have a periodic cap which limits the amount a rate can increase for each adjustment.