What Is an ARM Loan Mortgage?

An ARM, short for adjustable rate mortgage, is a type of mortgage that offers borrowers a variable interest rate. Understanding how an ARM functions can help you decide whether you would benefit by getting one rather than a fixed-rate mortgage.

Function

An ARM periodically changes its interest rate to equal an interest rate index plus your margin. Common interest rate indexes for ARMs include the LIBOR (London Interbank Offered Rate) and COFI (Cost of Funds Index). The margin gets added on to the index and varies based on how risky of a borrower you are considered.

Benefits

ARMs offer lower introductory rates, which can allow you to buy a bigger home than you could otherwise afford--if you expect your income to increase before the introductory period ends. In addition, if rates fall, your mortgage rate will drop without you having to pay for refinancing.

Warning

When considering an ARM, inquire about how much your monthly payment could rise if interest rates increase. Some ARM mortgages have interest rate caps, which limit the amount an interest rate can go up either per adjustment or over the life of the loan.

References

• Federal Reserve: Consumer Handbook on Adjustable-Rate Mortgages
• Bankrate: ARM vs. Fixed-Rate Mortgage
• Bankrate: Understanding Adjustable-Rate Mortgages