Early in the ARM's loan term, its rates will almost always be less than that of a fixed-rate loan. Because the borrower agrees to accept the risk of changing rates over the life of the loan, he or she is rewarded with a lower initial rate. ARMs come in many varieties. Some adjust their rates every year, while others alter them every three or five years. Loan rates are tied to a number of interest rate indexes.
Banks track on a margin, or spread, of two to four percentage points to the underlying index.
This is calculated by the Federal Home Loan Bank of San Francisco. Most ARMs offer two built-in caps to protect you from enormous increases in monthly payments. A periodic rate cap limits how much your payment can rise at any one time. For example, your loan agreement might stipulate that your rate cannot go up more than two percentage points a year. A lifetime cap limits how much the rate can rise over the term of the loan.