Adjustment Periods

One of the most important things to learn about adjustable rate mortgages (ARMs) is what the adjustment period represents and how it is expressed through the numbers connected with an ARM. When these numbers are casually tossed off, you should be able to quickly know what they mean.

The adjustment period is the amount of time between changes in your interest rate. However, speaking of a single adjustment period is somewhat misleading. In reality, there are two separate adjustment periods for any ARM you will encounter. The first is the initial period of your loan. During this period, your interest will remain the same as it was on the day you closed.

The second period, often simply referred to as the adjustment period, measures how often your rate can change after the initial period is ended. The initial period is generally longer than the adjustment period, or at the very least equal to the adjustment period. This allows you to hang on to the lower initial interest rate for a long enough time to compensate for the possibility of a higher interest rate down the road.

The two adjustment rate periods are often stated up-front, with terms like a 1-1, 3-1, or 5-1 ARMs. The first number refers to the initial period (one-year, three-year, or five-year in these examples). The second number refers to the adjustment period (the loans in the example are all adjusted annually). For example, suppose you have a 5-1 ARM with an initial rate of seven percent. Your rate and payments would stay constant for the first five years. After this five-year period is up, your lender could adjust the rate annually. The amount of the adjustment would depend on what index your ARM is tied to.