How is the Interest Rate on an Adjustable Rate Mortgage Determined?
There are a number of factors that you need to know when it comes to how an adjustable rate mortgage is determined.
The first thing you need to know about adjustable rate mortgages is that there are two basic periods to your loan. The first period of time is when you will be paying a fixed interest rate. This can be from anywhere from a month to ten years.
This means that when you agree to an adjustable rate home loan you will be agreeing to a home loan that is fixed at the given rate of a specified index for the agreed upon period of time, as well as a margin which won’t kick in until the second period kicks in. Just as an example, let’s say that the day you sign your home loan the rate is at 6%. That is what you will pay until the agreed upon period of time is over; lets say 6 months for the purposes of this example.
Once the fixed sixth month period is over your mortgage rate will become adjustable. If since signing your home loan papers the index your loan is tied to went up to 7%, you will now be paying 7% plus the margin which will likely be several additional points on top of the new rate.
There are however a few conditions. Namely that the rate cannot go up above the maximum rate increase specified within your contract, and that there is a cap on each individual rate increase, meaning that each time your rate goes up it cannot go up by more than an agreed upon percentage, usually 1% - 2%.
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