Financial Glossary: Adjustable Rate Mortgage (ARM)


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Adjustable Rate Mortgage (ARM)

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Adjustable Rate Mortgage (ARM)

Adjustable Rate Mortgage (ARM)

A loan in which the Interest rate is periodically adjusted, moving higher or lower in the same ratio as a pre-selected index such as Treasury Bill rates.

An adjustable rate mortgage (ARM) is a mortgage loan where the Interest rate on the note is periodically adjusted based on a variety of indexes. Among the most common indexes are the rates on 1-year constant-maturity Treasury (CMT) securities, the Cost of Funds Index (COFI), and the London Interbank Offered Rate (Libor). A few lenders use their own cost of funds as an index, rather than using other indexes. This is done to ensure a steady Margin for the lender, whose own cost of funding Will usually be related to the index. Consequently, payments made by the borrower may change over time with the changing Interest rate (alternatively, the term of the loan may change).

This is not to be confused with the Graduated Payment mortgage, which offers changing payment amounts but a fixed Interest rate. Other forms of mortgage loan include Interest only mortgage, Fixed Rate mortgage, negative Amortization mortgage, and Balloon Payment mortgage.

Adjustable rates transfer part of the Interest rate Risk from the lender to the borrower. They can be used where unpredictable Interest rates make Fixed Rate loans difficult to obtain. The borrower benefits if the Interest rate falls and loses out if Interest rates rise.

Adjustable rate mortgages are characterized by their index and limitations on charges (caps). In many countries, adjustable rate mortgages are the norm, and in such places, may simply be referred to as mortgages.

Posted by Henley & Partners Group Holdings Ltd, Catalyst Financial Partners LLC

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