How Does Rate Change Affect a 6/1 ARM?

By Bankrate.com

Dear Dr. Don,I have a 6/1 ARM that is going to have a rate change in October of this year. The paperwork states that the rate is based on the Libor. Does that mean the rate will go up or down based on the Libor at that time; or does the rate go up by 1% in October? I am concerned, as property values are down and I don't know if I will have the equity to refinance.-- Diane Dilemma

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Dear Diane,A 6/1 adjustable-rate mortgage, or ARM, is a hybrid mortgage structure. The initial interest rate is in force for six years. The interest rate resets after six years and from then on resets annually. So the 1 in the 6/1 ARM stands for how often the interest rate resets after the initial fixed-rate period.

Libor stands for the London Interbank Offered Rate, and it's the rate at which banks loan reserves in the London market. There are a host of different Libor rates, from an overnight rate out to several years. Review your loan documents to figure out which Libor rate is used in calculating your mortgage interest rate when the loan resets. Bankrate tracks these rates here.

At the reset date in October, the mortgage rate will change to reflect the current Libor level plus a pricing spread or margin. The change in the interest rate can be limited by restrictions placed on it in the loan document. There may be a floor rate that the reset rate cannot fall below. There often is a cap on how high the interest rate can go in one reset, and the loan may also have a lifetime cap on the upward change to your mortgage interest rate.

Libor rates are substantially below where they were six years ago, when they were more than 4%. Your mortgage reset may be a pleasant surprise, even if there's a floor rate in effect on the reset.

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