Definition
An Adjustable-Rate Mortgage (ARM) is a type of mortgage loan where the interest rate on the note is periodically adjusted based on a specific index, which reflects the cost to the lender of borrowing on the credit markets. As a result, payments made by borrowers may change over time with fluctuations in interest rates. Compared to fixed-rate mortgages, ARMs usually start with lower initial interest rates, making them attractive to borrowers in the early stages of the mortgage.
Examples
- 3/1 ARM: A 3/1 ARM has a fixed interest rate for the first three years, after which the rate adjusts every year.
- 5/1 ARM: In this case, the interest rate is fixed for the first five years, and then adjusts annually.
- 7/1 ARM: Here, the rate is fixed for seven years before it begins to adjust annually.
Frequently Asked Questions
What is the main advantage of an ARM?
The primary advantage of an ARM is the lower initial interest rate compared to a fixed-rate mortgage. This can lead to lower initial payments.
What risks are associated with ARMs?
The main risk is the potential for higher payments if interest rates increase over time.
How does the interest rate adjust in an ARM?
The interest rate on an ARM adjusts based on a predetermined financial index plus a margin set by the lender.
What are caps in ARMs?
Caps are limits placed on the amount the interest rate can adjust, both at each adjustment period and over the life of the loan.
Is an ARM suitable for everyone?
No, ARMs are typically best suited for borrowers who plan to sell or refinance before the adjustment periods begin or who anticipate a rise in their income.
Related Terms
Fixed-Rate Mortgage (FRM)
A mortgage that has a fixed interest rate for the entire term of the loan.
Hybrid Adjustable-Rate Mortgage (Hybrid ARM)
A type of ARM that has an initial fixed-rate period before switching to adjustable rates.
Renegotiated-Rate Mortgage
A mortgage where the interest rate may be periodically renegotiated between the lender and the borrower.
Variable-Rate Mortgage
Another term for Adjustable-Rate Mortgage, where rates vary.
Caps
Limits on how much the interest rate or the loan payment can increase per adjustment period or over the life of the loan.
Online References
Suggested Books for Further Studies
- “The Mortgage Professional’s Handbook: Succeeding in the New World of Mortgage Finance” - by Jess Lederman and Andrew Davidson
- “The Mortgage Encyclopedia: The Authoritative Guide to Mortgage Programs, Practices, Prices, and Pitfalls” - by Jack Guttentag
- “Home Buying Kit For Dummies” - by Eric Tyson and Ray Brown
Fundamentals of Adjustable-Rate Mortgage (ARM): Real Estate Finance Basics Quiz
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