Definition
The Initial Rate Period in the context of an Adjustable-Rate Mortgage (ARM) refers to the initial span of time from the origination of the mortgage until the first scheduled interest rate adjustment. During this period, the interest rate is fixed and remains constant. Once this period ends, the interest rate is recalibrated to match a specified index, typically leading to an increase or decrease in the mortgage payments.
ARMs typically come with initial rate periods ranging anywhere from a few months to several years. The specific terms, including the duration of the initial rate period and the formula for future adjustments, are detailed in the loan agreement.
Examples
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Example 1: Initial Rate Period of 5 Years
- Suppose a borrower takes an ARM with an initial interest rate of 3%, fixed for the first 5 years. This 5-year period is the initial rate period. Upon reaching the end of this period, the mortgage contract specifies that the interest rate will adjust annually based on the LIBOR index plus a margin of 2%. If the LIBOR index stands at 1.5% at the time of the first adjustment, the new rate will be 3.5%.
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Example 2: Initial Rate Period of 1 Year
- Consider an ARM originated with an initial interest rate of 2% for the first year. The contract sets the interest rate to the current yield on 1-year Treasury securities plus 2 percentage points. At the end of the initial rate period, the Treasury yield is 2.5%, making the new interest rate 4.5%.
Frequently Asked Questions (FAQs)
What happens after the initial rate period of an ARM?
After the initial rate period, the interest rate on the loan adjusts according to the specified index and margin outlined in the loan agreement. This adjustment can result in an increase or decrease in the monthly mortgage payments.
How long does the initial rate period typically last?
The duration of the initial rate period can vary but commonly lasts for 1, 3, 5, 7, or 10 years. Shorter periods often feature lower initial rates but higher risks of significant rate adjustments.
Can the interest rate decrease after the initial rate period?
Yes, if the index to which the ARM is tied decreases, the interest rate may also decrease. However, the terms of the loan often include rate caps that limit how much the rate can decrease.
Is the initial rate period and interest rate the same for all ARMs?
No, initial rate periods and initial interest rates can differ among various ARM products, depending largely on lender policies and the specific terms negotiated in the loan agreement.
Related Terms
- Adjustable-Rate Mortgage (ARM): A type of mortgage in which the interest rate applied on the outstanding balance varies throughout the life of the loan.
- Index: A benchmark interest rate, such as the LIBOR, used to derive the new interest rate for an ARM after the initial rate period.
- Interest Rate Adjustment: The process of altering the interest rate on an ARM according to the changes in the chosen index.
- Margin: The fixed amount above the index rate used to adjust the interest rate on an ARM.
Online Resources
- Investopedia - Adjustable-Rate Mortgages (ARMs)
- Consumer Financial Protection Bureau (CFPB) - Adjustable Rate Mortgages
- Mortgage Research Center - APR
References
- “The Truth About Adjustable-Rate Mortgages,” The Mortgage Reports
- “Adjustable Rate Mortgage Analysis,” Mortgage Bankers Association
- “Consumer Handbook on Adjustable-Rate Mortgages,” Federal Reserve
Suggested Books
- The Mortgage Encyclopedia: The Authoritative Guide to Mortgage Programs, Practices, Prices and Pitfalls, Second Edition by Jack Guttentag
- Mortgages 101: Quick Answers to Over 250 Critical Questions About Your Home Loan by David Reed
- Home Buying Kit For Dummies by Eric Tyson
