But people used to think they could get 20 percent a year on their stock investments, and now both of those assumptions have proven wrong. How high depends on the performance of a market index, which can be anything from the yield on short-term government debt securities to the average interest western U.S. banks pay to depositors. Lenders take that index, add a margin and compute a new rate for borrowers at dates specified in the ARM contract. Some ARMs have initial periods as short as a year or even six months. Others, known as hybrid ARMs, have fixed rates for three, five, seven or 10 years, then rates that adjust each year thereafter.
Borrowers generally get the lowest teaser rates on loans with the shortest initial fixed period.
Regardless of the exact term, all of them usually cost less at first than 30-year fixed rate loans. Quite a bit, as illustrated by this example. Working with a Chase Manhattan Corp . mortgage officer, we calculated what the borrower's rate and payment would have adjusted to at the beginning of 1999 and 2000. We also had Chase figure what if the 1-year Treasury yield rose another percentage point by January 2001 and what if it dropped by the same amount. ARMs generally adjust to the index value 45 days prior to the adjustment date.