Adjustable Rate Mortgage Loans, as their name implies, have rates that adjust over time.

There are several types and terms of adjustable rate mortgage loans. Common types are 3/1, 5/1, 7/1, and so on.

The first number in the name of adjustable rate mortgage loans indicates the period of time that the rate will be fixed. In the case of the 5/1 ARM, the rate will be fixed for five years. Adjustable rate mortgages loans can adjust differently from one another after the fixed rate period ends.

This means that they adjust at different intervals over time, and have different amounts that they can adjust at any one time. Adjustable rate mortgages also have what are called floors and ceilings that determine how high or low the rate can ever go.

Rates on Adjustable Rate Mortgage Loans have two components that make up the rate. These are called the index and the margin.

The index component of the rate on adjustable rate mortgage rate loans is based on some index, such as Treasury Bills, or what is called the LIBOR. All indices will undoubtedly change over time and rates on adjustable rate mortgages will be determined by the index on which the rate is based.

The margin component of adjustable rate mortgages remains fixed over time, and is added to the index to arrive at an interest rate. An example will help.

Let’s say that a lender is offering some adjustable rate mortgage loans that are all based on the LIBOR. Let’s also say, and the numbers are for illustration purposes, that the LIBOR is at 2.5%. If the lender has a margin of 2%, the rate the borrower pays is 4.5%, or the two added together. As the index on which adjustable rate mortgage loans are based changes, so will the rates.

Adjustable rate mortgages have both pluses and minuses over their fixed rate counterparts. The pluses are that rates or often lower on adjustable rate mortgage loans, and if you know you are only going to be in a property for several years, you can save money by getting the ARM.

The advantage to fixed rate mortgages over adjustable rate mortgage loans is that the payment will remain fixed for the life of the loan, meaning that if rates skyrocket over time, you are protected from any payment increases.

Your long term goals should be the determining factor in whether you are shopping for either fixed rate mortgage or adjustable rate mortgage loans.