Adjustable Rate Programs An adjustable rate loan is a loan that changes its rate during the life of the loan. There are limits to how much or when it will change, but it does change. Its new rate will be determined by the economic conditions at the time of the change, so it is impossible to predict these changes until they occur. There are parameters, however, that determine how the ARM (adjustable rate mortgage) will change. These are the term, the index, the margin, the period, the period cap and the life cap.  The term - This is whether it is a 30 year loan or a 25 year loan.  The Period - Basically, how often the rate will change. A 1 year arm has a period of 1 year. A 5/1 Arm has an initial period of 5 years, and then it will change every year after the initial change. The index - This is the economic indicator that the lender will use when determining your new rate. Common indicators are the yield on the 1 year Treasury bill, the LIBOR index, the MTA, which is a blended average of 1 year Treasury bills over an 18 month period, or the COFI index, which is an index that averages saving accounts and CD yields.  The margin - This is the amount added onto the index when determining your actual rate. To explain this better, let’s assume the index was the 1 Year Treasury bill and it had a yield of 3.5% at the end of the Period. Let’s also assume a margin of 2.75%. Your new rate would be 3.5% plus 2.75%, or 6.25%. The period cap and life cap - Theses determine the maximum percentage the rate can increase or decrease during the life of the loan. The period cap determines the most the loan will change in any given adjustment, comparing it to the period before. The life cap is the most it can change from where the initial rate started. One major difference between an adjustable and a fixed rate loan is how the loan is affected when a home owner pays off a portion of the loan. On a fixed rate, a principal reduction does not decrease the mortgage payment. Instead, it will shorten the time it takes to pay it off. On an ARM, the term stays the same, so it will still be a 30 year or 15 year loan. Instead, when the rate adjusts, the new payment will be calculated based on what is owed at that time, so there will be a reduction in the monthly payment.  Most adjustable mortgages are conventional loans, but VA and FHA offer them also. Down payment and credit requirements can be stricter on these programs. Discuss this with your loan officer.