They usually offer slightly lower interest rates than 30-year loans, but you must make substantially larger monthly payments. If you want to make prepayments on your mortgage, contact your lender to arrange a schedule and make sure that you will not be assessed a penalty. The best way to avoid penalties is to be sure that your mortgage loan contract allows you to make prepayments. 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 2 to 4 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.