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Adjustable Rate Mortgage

An adjustable-rate mortgage is one in which the interest rate can change at the end of predetermined periods of time. For example, the interest rate can change at the end of every six months, or at the end of every year, throughout the life of the loan.

The interest is adjusted according to changes in a published index that reflects the current interest rate, such as the LIBOR, Prime Rate, or Cost of Funds Index. One index that is often used to determine interest rates is that of United States Treasury bonds. At the end of each predetermined time period, the index will be checked. If the index reflects an increase, so will your mortgage rate. If the index has gone down, your monthly mortgage payment will go down, too. Borrowers and lenders have no control over the changes in the index, but most adjustable-rate mortgages have a maximum interest rate cap.

The most significant advantage to choosing an adjustable-rate mortgage is that you may end up with lower monthly mortgage payments than you would with a fixed-rate mortgage. There is the risk, however, that interest rates will rise, and your monthly payment can become overwhelming.