What is change frequency?
The change frequency refers to how often a payment and/or interest rate changes in an adjustable-rate mortgage, or ARM. Also known as the adjustment frequency, the interest rate changes on the reset date for that specific ARM product.
An adjustable-rate mortgage (ARM) is a mortgage loan with payments and interest rates that are periodically reset based on a specific index such as a key index rate set by the Federal Reserve, the one-year Treasury bill or the London Interbank Offered Rate (Libor).
As such, an ARM is designed to make sure the mortgage interest rate matches prevailing market conditions.
After an initial period during which the rate doesn’t change, it normally changes yearly, making its change frequency once a year after the initial fixed rate period.
Even so, the rate can adjust as often as once a month or as occasional as once every five years, depending on the loan product.
For example, a 5/1 ARM means a borrower has a fixed rate for the first five years of the loan. Then, the rate adjusts annually each year after that. With another type of ARM — the 3/3 ARM, the fixed rate lasts for the first three years, and then adjusts every three years after that.
To be sure, the initial rate is critical when it runs for 10 years before the change frequency kicks in. On the other hand, it is almost insignificant when it is for a one-month period.
A lender cannot increase the ARM rate above a certain point, because there are limits on how high a rate hike can go.
In addition, ARMs are only “risky” when used over the long term. As a short-term financing tool, they offer some compelling advantages like being able to switch to a fixed-rate mortgage if and when that’s possibly financially.
Change frequency example
TBD State Bank offers Steve and Gretchen a 5/1 ARM, with an initial fixed rate of 2.5 percent. The loan amount is for $200,000, which means Steve and Gretchen will pay $790.24 monthly for the first five years.
Applying the new rate to the remaining balance, the borrower will pay $905.65 monthly at least for the 12-month period of year six. This figure can be adjusted on the first date of the next rate-change period.