Adjustment Interval Details

Adjustment interval is a component of an Adjustable Rate Mortgage (ARM). An Adjustable Rate Mortgage is a type of mortgage that has a dynamic interest rate. The interest rate is governed by a financial index that’s followed by the bank. London Interbank Offered Rate (LIBOR), or commonly referred to as Inter-Continental Exchange LIBOR is a popular financial index that’s being followed by most banks in the UK.

A financial index such as LIBOR is calculated from the average of interest rates submitted by leading banks in London, UK. Financial indexes can go up and down. The changes are relatively small unless there’s an ongoing financial crisis. If the financial index numbers go up, so will the mortgage monthly payment and vice versa.

The bank will look at the financial indexes at a scheduled time as agreed on the initial contract of the Adjustable Rate Mortgage. Then the bank will adjust the interest rate. This is what’s called the adjustment interval. Borrowers can choose the adjustment interval rate before fully committing to an ARM. Banks usually offer adjustment interval rates between three months to five years.

Example of Adjustment Interval

Adjustment intervals only exist in Adjustable Rate Mortgages. The interest rate in an ARM consists of two types: fixed and variable/dynamic. A 10-year 5/1 ARM means that the interest rate in the first five years will be fixed, while the rest will be dynamic, following the financial indexes chosen by the bank. Even though banks offer a variety of adjustment intervals, borrowers usually choose a one-year adjustment interval.

Let’s say Richard is applying for a $50,000 10-year 5/1 ARM with a one-year interval adjustment. The fixed rate will be 5% for five years. After that, the interest rate will change depending on the LIBOR index. Richard will pay $6.364 annually for the first five years because of the 5% fixed interest rate.

In the sixth year, the LIBOR index climbs up, and Richard’s ARM interest rate also got bumped up from 5% to 7%. As a result, Richard paid $6.594 in the sixth year. Luck is on Richard's side in the seventh year because the LIBOR index slackens, decreasing Richard’s interest rate from 7% to 5.25%. Richard paid $6.402 in the seventh year.

Significance of Adjustment Interval

An Adjustable Rate Mortgage is considered a strong alternative to the traditional 30-year fixed-rate mortgage. The low initial interest rate is the main selling point of an ARM. Furthermore, an ARM is extremely flexible since you can change almost all the mortgage components. In the end, the adjustment interval is one of the most important aspects of ARM.

Adjustment intervals allow for massive leverage for both the lender and borrower and that leverage comes in the form of risk management. A shorter adjustment interval brings more risk to the borrower since their interest rate is further exposed to the financial index’s volatility. Longer adjustment intervals bring more risk to the lender since the borrower only pays a small amount and the borrower only gets a thin margin.

So, what’s the key to unlock the full potential of ARM’s adjustment interval? Financial research. An educated borrower will stay on top of economic shifts. They evaluate currency value, foreign resource dependency, and average productive age—all of which determine how the financial index behaves. If the borrower feels the financial market is too volatile, they might choose the longest adjustment interval option.

Lenders, on the other hand, want to cater to their customers' needs best. Providing a larger option on the ARM adjustment interval is a great way to boost your customers' confidence in the bank. It also sends a statement to the market that the bank values its customers more than its profit.