Moneyzine
Contents
/Personal Finance/Adjustable Rate Mortgage (ARM)

Adjustable Rate Mortgage (ARM)

Moneyzine Editor
Author: 
Moneyzine Editor
2 mins
September 25th, 2023
Advertiser Disclosure

Definition

Also known as a variable rate mortgage, an adjustable rate mortgage (ARM) is a home loan whereby the interest rate charged can change over the term of the loan. Typically, the rate adjusts, or tracks, with a well-defined index such as the Cost of Funds Index (COFI) or the London Interbank Offer Rate (LIBOR).

Explanation

Since the interest rate can change with an adjustable rate mortgage, the monthly payments due on the loan can rise or fall over the term of the loan. This behavior is in contrast to a fixed rate mortgage, whereby the interest rate is constant over the term of the loan. Oftentimes, an interest rate cap is placed on the loan, whereby the rate charged can be no higher than a pre-determined value. These can be periodic caps (per adjustment period) or lifetime caps (life of the loan).

Fair comparisons of all loan types can be made using the annual percentage rate, or APR. The lender's risk of rising or falling interest rates is passed on to the borrower with an ARM. By doing so, the lender is able to offer more attractive initial interest rates to consumers when compared to conventional loans.

Example

Bank A is advertising a 30 year 5-year ARM, with an initial interest rate of 3.000% and an APR of 3.015%. The loan has a lifetime cap of 8.000% and a periodic cap of 1.000%. This information is translated as follows:

The length of the loan is 30 years. The initial rate of 3.000% cannot change in the first five years. After that, the rate will track a well-known index and cannot increase more than 1.000% at the point of each adjustment period.

Related Terms

Related Content

How to Make a Million Dollars in 10 Years
Truthfully, this title should actually be “How to Make a Million Dollars in 10 Years Without Going Into Debt", but that is just getting a little too winded for my liking. It’s true though!
March 26th, 2024
How to Apply Maslow’s Hierarchy to Your Money This Year
You might vaguely remember your psychology teacher talking about Maslow. He pointed at a picture of a triangle as you nodded off in the back of the school room.
March 27th, 2024
How to Tackle Multiple Savings Goals
When there’s only so much money to go around, there are often multiple savings goals competing for your money. Think of the young professional who’d like to get a more reliable car, buy a house, and save for retirement. Or consider the young family that’s saving for college, retirement, and a bigger house.
March 22nd, 2024
The Countdown to Early Retirement: 10 Expenses to Eliminate
Dreaming of waving goodbye to the daily grind five years ahead of schedule? The road to early retirement is paved with more than good intentions; it requires a meticulously crafted strategy with surprising twists. It's not solely about what you should be doing—like diligently saving a portion of your income or investing wisely—but also about what you need to stop doing.
March 22nd, 2024
What’s Your One Page Financial Plan? Mapping out Your Future
“What’s your one page financial plan?” — This is the absolute best question that I’ve heard asked in a long time. Instead of talking about your hot stock pick or your fancy investment that shields you from paying taxes, I think it’s time for all of us to step back and ask ourselves the most intelligent question of all, “Why the heck do I care about money anyway??”
March 14th, 2024

Contributors

Moneyzine 2024. All Rights Reserved.