With an adjustable-rate mortgage. the rate is typically fixed, or stays the same, for the first few years, and then it begins to adjust. Once the rate begins to adjust, the changes to your interest rate are based on the market, not your personal financial situation.
To calculate your new interest rate when it’s time for it to adjust, lenders use two numbers: the index and the margin .
Index + Margin = Your Interest Rate
The index is a benchmark interest rate that reflects general market conditions. The index amount changes based on the market, and is maintained by a third party. It is these changes in the index amount that drive the changes to your interest rate.
The lender decides which index your loan will use when you apply for the loan, and this choice generally won’t change after closing. The most commonly used index for mortgages is the one-year LIBOR, which stands for the London Inter-Bank Offer Rate. You can look up the current LIBOR rates in major newspapers such as the Wall Street Journal or on financial websites such as bankrate.com .
The margin is set by the lender when you apply for a loan, and this amount generally won’t change after closing. The margin amount depends on the particular lender.
Tip: You should pay attention to the margin when you’re shopping for your loan because it can vary a lot between different lenders. You can also negotiate the margin just like you would negotiate the rate on a fixed-rate loan.
Here’s an example of how indexes and margins work:
Let’s say you are shopping for a mortgage, and you are offered a 5/1 ARM with an initial rate of 3.5% percent and an adjustable rate of LIBOR (the
index) + 2.25% percent (the margin).
In this case, 5/1 means that the initial rate of 3.5% will be fixed for the first 5 years, and the rate will adjust every year starting in year 6. Learn more about how to read ARM product names.
At the beginning of the sixth year of your loan, your rate will adjust. Let’s assume that the One-Year LIBOR index is 2.5% at that time. Your new rate when this mortgage begins to adjust will be 4.75%. Here’s the math:
2.5% (LIBOR) + 2.25% (margin) = 4.75% (your rate)
At the beginning of the seventh year of your loan, your rate will adjust again (and every year thereafter).
Now, let’s assume the LIBOR is 3%. Your new rate would be 5.25%.
3% (LIBOR) + 2.25% (margin) = 5.25% (your rate)
With this loan, whenever the one-year LIBOR index is higher than 1.25%, you will have a higher interest rate than your original rate.
Tip: Most adjustable-rate loans also include caps that limit how much the rate can increase at a given adjustment interval, even if the index has changed by more. Learn more about rate caps.
Tip: If you have a problem with your mortgage, you can submit a complaint to the CFPB online or by calling (855) 411-CFPB (2372).
Tip: If you’re behind on your mortgage, or having a hard time making payments, you can call the CFPB at (855) 411-CFPB (2372) to be connected to a HUD-approved housing counselor today. You can also use the CFPB's "Find a Counselor " tool to get a list of U.S. Department of Housing and Urban Development (HUD)-approved counseling agencies in your area.
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