An adjustable rate mortgage is a mortgage on which the borrower is required to pay an interest rate which can change over time. This is the most common type of mortgage. Changes in the mortgage interest rates are based on a declared interest rate index. This index is usually the interest rate set by the central bank in the economy and, at any rate, must be specified in the initial mortgage agreement. Usually, home equity line of credit feature some limitations on the degree to which the interest rate or the related payments on the underlying debt can vary within a given time period. These limitations are formally known as “caps”. Typical caps might include a provision that the interest rate vary by no more than 2% within one year, or that no more than two interest rate adjustments be made within a twelve month period.
Some home equity loans may be offered on the basis of rates which are fixed for a period of time and then are allowed to vary. Because they carry more uncertainty than fixed rates mortgages, adjustable rate mortgages to some extent represent a gamble on the future state of the economy, and can either impose unexpected hardship on the mortgage-holding families or result in an unexpectedly low financial burden for them if the economy moves in the right way.
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