What happens when an ARM interest rate adjusts?
ARM loans come in many types so you will have to identify which type you have to find out how your loan will adjust.
Each ARM is based on an index plus a margin.
This index is usually representative of what a financial entity pays for the liquid assets used to fund these loans. For example the LIBOR (London Inter Banking Offering Rate) is the cost of borrowing the assets. The COSI or Cost Of Savings Index, is the interest the bank pays on savings accounts (so they can lend it to you or use it as leverage to lend other money to you.)
So Index is the cost and the Margin is the profit.
ARM loans also have other features like CAPS.
The caps are displayed like this: 2/2/6 or 5/2/5
-The first number is how many percentage points the loan can adjust the first time it adjusts.
-The second number is how much it can adjust at every other adjustment point.
-The last number represents the LIFE cap, or the maximum the loan can go up over the entire life of the loan.
So for example: If you have a 5/1 LIBOR at 4% with 2/2/5 Caps and a margin of 3% and today is the adjustment day. The 1year LIBOR is at 3.125% plus the 3% margin is 6.125$ EXCEPT that you have a 2% cap, so your new rate is 6% (for the next year anyway when it will adjust again) You can find out what kind of ARM loan you have by reviewing the Truth In Lending Disclosure in your closing papers. Hope that Helps!