ARMs Glossary

Before you start shopping for an ARM loan, become familiar with the following terms:

Adjustment period. By definition, an adjustable-rate mortgage has the potential for rate and payment changes at specific predetermined periods, usually every year, every three years or every five years. Other adjustment periods vary from six months to 10 years. Some ARMs combine two adjustment periods. For example, a 3/1 ARM has a fixed rate for the first three years and then adjusts annually for the remaining life of the loan.
Caps are limits placed on payments, interest rates and/or the balance of a loan. Caps can limit increases by either a dollar amount or a percentage. The most common interest rate caps specify a 1% or 2% maximum rate increase per adjustment and a 5% to 6% maximum rate increase over the life of the loan.
Index is a measurement used by lenders to determine changes to the interest rate charged on ARMs. Indexes are based on published, independent measures of current interest rates. If the index increases, the interest rate increases unless an interest rate cap is reached.
Margin represents the lender’s cost of doing business plus profit. This amount is typically two or three percentage points, which is added to the index to compute the interest rate. Once the lender specifies the margin, it remains fixed.
Negative amortization occurs when the amount of the monthly payment does not cover the monthly interest due. In such cases, the unpaid interest is added to the loan amount.