An adjustable rate mortgage typically begins with an interest rate that is 2 to 3 percent below the comparable fixed rate mortgage and the rate is adjusted at set intervals. The adjustment is determined by the index associated with the type of ARM. As the index fluctuates so does the interest rate. The indices can be referenced in the Wall Street Journal. Some common indices are described below:

A One-Year T-Bill, which is the interest rate earned on treasury notes issued by the U.S. government with a maturity date of one year. The interest rate varies, according to market conditions.

Cost-of-Funds Index (COFI), which tends to be more stable than the One-Year T-Bill rate. The margin is the amount, say 2.5 to 3.0 percent, which is added to the index at the time of adjustment.
Consider an ARM loan when:

• Fixed interest rates are high
• You only plan to keep the loan for a short while
• You only plan to stay in your home for a short while

A buydown mortgage is a fixed rate loan that requires you or the property seller to pay additional points at closing in exchange for a lower interest rate for the first one or two years. Typically, the rate drops two percent the first year, one percent the second year, then goes back up to the full interest rate. For example if you have a buydown fixed-rate loan at 8 percent, additional points are paid up-front. The first year you are only charged 6 percent, the second year you would be charged 7 percent, and the third and subsequent years you would be charged 8 percent.

Consider a buydown when:

• Fixed-rate interest rates are low, but you cannot qualify for a loan
• The seller is paying the closing costs
• You expect your income to significantly increase in the next year or two