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How often do adjustable-rate mortgages change?

How often the interest rate changes on an adjustable-rate mortgage depends on the specific terms of your adjustable-rate mortgage (ARM). So before you sign on for an ARM, make sure you understand exactly what the terms are.

A typical ARM adjusts once a year. However, you can also find ARMs that adjust every six months or after longer intervals, such as two-year ARMs. You can find some other types of ARMs that don't adjust at the same, fixed interval, but they have more creative patterns. For example, a 5/1year ARM means you have a fixed rate for the first five years of the loan, but then it adjusts annually each year after that. Another type of creative ARM is the 3/3 year ARM, which has a fixed rate for the first three years, and then adjusts every three years after that.

The other critical term to understand when entering into an ARM loan is not just how often your interest rate will adjust, but what is the basis for the adjustment. Interest on an ARM loan can be tied to any number of market indicators, such as one-year U.S. Treasury bills, certificates of deposit, and the London Inter-Bank Offer Rate (LIBOR; this is the rate at which banks lend each other money). Your lender will usually look at an index of such market indicators, rather than tie the interest rate to a single indicator. However, your lender will also add some points (anywhere between two and four) to that index to set your specific interest rate. While the assumption is that if these market indicator rates go down, it means your interest rate will go down, this may not be so [source: Federal Reserve]. Your interest rates will surely go up if the market indicators do, but check the terms of your specific ARM to find out if your interest rate will go down with the market, as well.