The adjustment interval is an important aspect of an ARM. It is the time period between potential rate changes.
An ARM differs from a fixed rate mortgage. With a fixed rate mortgage, the interest rate, and therefore the monthly payment, remains the same throughout the term of the loan. With an ARM, the interest rate can change, or adjust, based on an index. An index is a published interest rate against which lenders measure the difference between the current interest rate on an ARM and the interest rate earned by other investments. For example, the lender can compare the current rate on the ARM with the average monthly interest rate on loans closed by savings and loan institutions. Using this difference, the interest rate on the ARM is adjusted up or down.
Lenders cannot look at this difference whenever they feel like it to adjust the rate on an ARM. They look at it at a specific time. Typically, it's once a year. This time period between adjustments, usually a twelve-month period, is referred to as the adjustment interval. The borrower can rest assured that his/her rate will remain the same for that interval until the next rate change.
Also, there is a limit to how much the interest rate can change. This limit is called a cap. Caps refer to a legally required maximum on how much the interest rate of an ARM can increase over the life of the loan. The overall cap limits the interest rate for the entire life of the loan. The periodic cap limits how much the interest rate can increase at each adjustment period. This means that your interest rate is not going to jump five points after one year.
Say the index rate rises 3 percentage points from 2.5 percent to 5.5 percent during an adjustment period. That would make an interest rate of 4.5 percent rise to 7.5 percent. However, a 2 percent cap keeps the interest rate at 6.5 percent. This keeps the borrower from having too great a jump in his/her rate.
Getting an ARM can be a little bit risky. Because the interest rate changes, the borrower does not know for sure what the monthly payment will be each year. During the adjustment interval the rate does not change, but that is usually only a twelve-month period. Once that time period is up, the interest rate on the ARM most likely will change.
