The rate on an Adjustable Rate Mortgage (ARM) is fixed for a pre-determined set of time and then adjusts, usually on an annual basis after that. ARMs can be fixed for different periods, the most common being 3/1, 5/1 and 7/1 ARMs. In each case, the first number indicates the number of years a rate is fixed and the second number refers to how often the rate adjusts. For example, a 3/1 ARM is fixed for 3 years and subsequently adjusts yearly after the initial 3 year period. In most cases, ARMs are amortized over 30 years. The amount an ARM can adjust annually and through it’s lifetime is typically as follows; On a 3/1 ARM, the most a rate can change each year once adjusting is 2% and typically the lifetime cap is 5 or 6%. A 5/1 and 7/1 ARM can typically adjust as much as 5% up or down on the first adjustment date and then no more that 2% each year thereafter with the same 5 or 6% lifetime cap. ARMs adjust according to an index and a margin. In most cases, ARMs are attached to the LIBOR index (London Interbank Overnight Rate) and generally adjust to 2.25 above that index.
