Business, Legal & Accounting Glossary
An ARM is an acronym standing for an adjustable-rate mortgage, a loan instrument commonly offered on residential properties. Unlike with fixed-rate mortgages, the interest rate on an ARM loan is tied to an index and may rise and fall accordingly. The 11th District Cost of Funds Index (COFI), the 12-month Moving Treasury Average (MTA), the 12-month Treasury Bill index (T-Bill), and the London Interbank Offered Rate (LIBOR) are among the indexes used as a benchmark/base rate for ARM loans. The initial mortgage and rate on an ARM can remain in effect for a period ranging from one month to seven years or more, after which it adjusts to the indexed rate plus any margin. This interval is called the adjustment period; the rate and payment adjusts after one year on a 1-year ARM and after three years on a 3-year ARM. Lenders typically add a margin of fixed percentage points to the benchmark rate of an ARM which is often based on the borrower’s credit record. For example, if the indexed rate is 3% and the margin is 4%, the borrower pays a full rate of 7% on their ARM. Interest rate caps may be applied in an effort to prevent the rate on an ARM from exceeding a specified limit. The hybrid ARM, a popular variation on the ARM, has a fixed rate of 3 to 10 years and is pegged to an index thereafter. Other variations of ARM include the interest-only ARM (I-O ARM) and the payment-option ARM.
Many people finance their homes using an adjustable-rate mortgage hoping that the economy stays healthy so that their interest rates will not go up.
She moved from a fixed-rate to an adjustable-rate mortgage just before the stock market lost half its value, and in the subsequent recession, saw her mortgage payments double.
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This glossary post was last updated: 13th February, 2020