The interest rate with this program periodically rises and drops based on different market indexes. You will be assuming risk if the market justifies the rate increasing, but can also tremendously benefit if the market justifies the rate to fall. This loan program is popular with homeowners who only plan on being in the home for a short period of time.
There are two main factors that go into determining the rate you pay, the index and the margin. The index rate is set by market forces and made public by a neutral third party. Margin is the number of percentage points that is added to the index as agreed upon with the loan program, this is how your adjusted rate is determined. Multiple indexes exist and each has its own way of determining fluctuation. CMT, LIBOR, MTA, COFI are examples of the indexes that are used for these loan programs.
It is very important to ask if and what are the limits to what the rate can be raised for the ARM at each review and over the entire life of the mortgage. Limits on a rate increase are known as “caps”, these caps are essential so you will have the ability to predict how your rate and monthly mortgage payment could change.