A fixed period adjustable rate mortgage is has a fixed rate for a certain amount of time followed by an adjustable period through the remaining term of the loan. The periods for which the loan is fixed are usually 1, 3, 5, 7 or 10 years. Once the loan becomes variable the interest rate is determined by adding the loan’s margin to the index that the loan is tied to. For instance, if the loan’s margin was 2.25% and the index value were 1.75% then the rate would be 4%.
These loans usually have three interim caps. The first cap governs how much the rate can go up in the first year that it is variable. The second cap how many times the loan can adjust in a year and the third cap is how much the rate can go up over the life of the loan. For instance, if a loan has 3/2/5 caps, the first time the rate adjusts, it could not go up more than 3%. The second cap in this instance denotes that the loan will adjust 2 times a year. The third and final cap shows that the loan will not ever increase more than 5 percent over the loan’s initial start rate.
The benefits of fixed period adjustable rate mortgages are that they come with a lower initial monthly payment, have lower payments through the initial period for which the loan is fixed and their rate usually goes down if rates should improve during the time that the rate is adjustable. The detractors are that there is a risk the rate might increase after the fixed period expires, payments may change over time and there’s a potential for higher payments should rates go up. Despite these risks, a fixed period adjustable rate mortgage can be a smart choice for a homeowner with clear life goals in mind.