 TITLE: What’s the Difference Between Fixed-Rate and Adjustable-Rate Mortgages? CONTENT: How Do Adjustable-Rate Mortgages Work?\n--------------------------------------\nThe nuances of how and when ARM rates adjust vary from loan to loan, but when they change, they almost always bring an increase in monthly payments. It's critical to read your loan agreement carefully before signing to make sure you understand all the specifics. These are variables to bear in mind when comparing adjustable-rate mortgages:\n*   **The length of the introductory period**: Five-year introductory periods on 30-year loans are common, but one-, three- and seven-year introductory periods are all possible.\n*   **The _index_ to which the floating rate is tied**: Indexes commonly used to set ARM rates include the yield on one-year constant-maturity Treasury (CMT) securities, the Cost of Funds Indices (COFI), and the London Interbank Offered Rate (LIBOR), which will be eliminated in 2021 but is still widely used to set ARM rates.\n*   **The _margin_ added to the index to determine the rate you pay**: The margin is a fixed percentage specified in the loan agreement. Margin ranges vary for different indexes (2% to 3% with the LIBOR is fairly common, for example). The lower the margin, the better the loan terms are for you because even a small percentage point difference can drastically change the cost over the life of a 30-year mortgage.\n*   **Rate adjustment frequency**: Once the introductory period ends, the rate on an ARM resets at regular intervals. Once a year is common, but two- and three-year periods may also be used, and some ARMs reset every six months. On the reset date, a new rate is calculated by adding the margin to the value of the index on that day; the new rate applies until the next reset date.\n*   **Rate caps**: To prevent extreme increases in ARM rates, ARMs typically limit the amount their interest rates can increase. A _periodic cap_ limits the amount the rate can increase from one adjustment period to the next, while a _lifetime cap_ limits the total amount the rate can ever increase over the introductory rate. Some ARM loan agreements also specify _payment caps_—limits on the amount your monthly payment can rise each readjustment period.\nWhen comparing mortgage offers, you'll often see shorthand that summarizes interest rate, introductory period and rate-adjustment frequency: A 3.8% 5\/1 ARM, for instance, has an introductory period of five years, after which it resets every year, while a 3.75% 3\/2 ARM has a three-year introductory period, after which the rate resets every two years. For more details on the ins and outs of ARMs, the Federal Reserve offers a very thorough handbook. END