Adjustable-rate mortgage terms to know
By Michael D. Larson• Bankrate.com

 

ARM definitions If you thought the language of lending was hard to understand, wait until you start looking at adjustable-rate mortgages. Unlike fixed-rate loans, they have many variations that make it tough to dissect the fine print. So you'll want to become familiar with these terms. Bankrate.com also offers a full set of mortgage loan terms
ARM	Stands for adjustable-rate mortgage, and it's any of several loans that feature a fixed rate and payment for a period, followed by a period of variable rates and payments.
3/1, 5/1, 7/1, 10/1, 7/23	Numerical nicknames for various ARMs. The first number stands for the number of years in the initial fixed period, while the second indicates how often the new adjusted rate will remain in effect thereafter. A 3/1 ARM, for instance, has three years of fixed payments at one rate, followed by 12-month blocks of fixed payments interspersed with annual adjustments. The total loan term would be 30 years.
Index	The index, or interest rate measurement, to which your ARM will adjust. A 1-year Treasury ARM will adjust based on the yield of the 1-year Treasury Bill, a government debt security.
Margin	The amount of percentage points, or spread, added to the index to come up with the rate your ARM will charge after each adjustment. If you have a 1-year Treasury ARM with a 2.75 percent margin, your ARM will adjust after the first year to the Treasury Bill yield plus 2.75 percent, or about 9 percent in early February.
Fully indexed rate	The rate the lender computes for your ARM by adding its margin to the index.
Caps	The ceilings and floors put in place for your ARM that restrict how much its interest rate can change in a given time period. Most ARMs have an annual adjustment cap, which limits yearly changes, and a lifetime cap, which limits the total allowable change over the full loan term.
Prepayment penalty	This bogeyman of the industry sometimes pops up with ARMs, so be careful. For instance, if you get a 5/1 ARM with the intention of selling the house and paying it off in four years, make sure the lender won't charge you to do so.