Adjustable Rate Mortgage (ARM)
Definition and meaning of Adjustable Rate Mortgage (ARM) in real estate.
An adjustable rate mortgage, often called an ARM, is a home loan with an interest rate that changes periodically based on the movement of a specific financial index. Unlike a fixed-rate loan, the monthly payments on an ARM can increase or decrease over time.
In more detail
ARMs typically begin with an initial period of fixed interest, which is often lower than the rate for a comparable fixed-rate mortgage. Once this introductory period ends, the interest rate adjusts at scheduled intervals based on market indicators, such as the Secured Overnight Financing Rate.
To protect borrowers, ARMs feature interest rate caps that limit how much the rate can increase during a single adjustment period and over the lifetime of the loan. These loans are popular among buyers who plan to sell or refinance before the introductory rate expires. However, borrowers must be prepared for the risk of rising payments if interest rates increase.
Key facts
| Category | Mortgages & Financing |
|---|---|
| Also known as | Variable-rate mortgage |
| Key feature | Fluctuating interest rate based on market index |
| Watch out for | Rate adjustment caps |
A buyer secures an adjustable-rate mortgage with a low initial interest rate for the first few years, after which the rate adjusts annually based on the performance of a designated financial index.
Frequently asked questions
How are interest rate adjustments calculated on an ARM?
The new rate is calculated by adding a fixed margin, set by the lender, to a floating index rate that reflects current market conditions.
What are the caps on an adjustable-rate mortgage?
Caps are limits on how much your interest rate can rise, including a limit per adjustment period and a lifetime ceiling that the rate can never exceed.