Adjustable rate mortgages generally operate in a particular way. There is a initial period during which the interest rate is fixed just like it is in the case of a fixed rate mortgage. This interest rate is usually much lower than what you get on a fixed rate mortgage. However the difference is that after this period is over the interest rate does not remain fixed as it does in the case of a fixed rate mortgage but is allowed to fluctuate according to the median index rate.

The initial interest rate period is for a much shorter time as compared to the entire length of the adjustable-rate mortgage. This period can typically range from one month to 7 years. In some cases of adjustable-rate mortgage the fixed interest rate may also be valid for the first 10 years but then the difference between the FRM and the ARM initial rate wil not be too great.

At the end of the initial rate period the rate rate is adjusted. The adjustment rule states that the new rate would equal the most recent value of a specified interest rate index plus a margin. For example if the index rate is 7% when the initial rate period ends and the margin is 2.5% than the new rate will be 9.5%. However this rule is also subject to two conditions.

- The first rule is that the increase cannot exceed any rate adjustment cap that was specified in the adjustable rate for each contract. Usually all adjustable rate mortgages have a clause for a cap as to the maximum amount of increase that can happen in any particular year as well as the maximum amount of interest that can be charged at any point of time during the life of the mortgage loan. An adjustment cap Is usually one or 2% but in some cases can be as high as 5% per year.

- The second condition is that the new rate cannot exceed the contractual maximum rate. As mentioned above in addition to the yearly cap on the interest rate there is also the maximum rate that the lender and charge the borrower at any point of time that the mortgage is in effect. Maximum interest rate are usually 5 to 6% over and above the initial rate that was offered.

After the initial rate period is over the interest rate is adjusted periodically. This period may or may not be the same as initial rate.. An adjustable rate mortgage may adjust the interest rate on annual, bi-annual or a monthly basis after the initial interest has ended.

**The Quoted Interest Rate**

The interest rate that is initially quoted on an adjustable-rate mortgage by the mortgage lender or in an advertisement is the initial rate and is known as the quoted interest rate.

Regardless of how long a period lasts. A borrower stands to see the maximum benefit if this initial rate lasts for a longer time. ARMs with initial low interest rate period of 3,5 and 7 years are common.

However, if the borrower intends to stay in the home after the quoted interest is over, then he needs to consider other factors like the rate index used by the lender as well as the margin rate used by him.

For example, the only significance of an initial rate on a monthly adjustable rate mortgage is that this rate may be used to calculate the initial payment.

**The Fully Indexed Rate**

The Index rate plus the margin rate is called the fully indexed rate for an adjustable-rate mortgage. The fully indexed rate based on the most recent of the index at the time that the loan is taken out indicates where the mortgage rate may end up when the initial rate period ends. If there is no change in the Index rate than the fully indexed rate will become the interest rate for the adjustable-rate mortgage till the time that the Index rate fluctuates.

For example, it is assumed that the initial rate on an adjustable-rate market is 5%. The fully indexed rate at that time is 7% and the rate adjustment is subject to a 1% rate increase cap. If the index remains the same the fully indexed rate based at the end of the second year.

Your loan officer may or may not have the index rate available with him so you may not find out from them what the fully indexed rate is. Mortgage lenders are also not obliged to reveal this information to the borrower. However the most recent value of the index rates can be found on the Internet as long as you know which index rate your mortgage lender is tying up to your adjustable-rate mortgage.