Adjustable Rate Mortgage

Adjustable Rate Mortgage (ARM)

This is a variable-rate mortgage loan with an interest rate that can change at specified intervals based upon the performance of an index which reflects the cost to the lender. The interest rate can move higher, lower or stay the same at adjustment time. The index is the main feature that makes this type of mortgage adjust up or down. The Prime Lending Rate and London Interbank Offered Rate (LIBOR) are 2 examples of an index. Added to the index at adjustment time is a fixed number, known as a margin, to determine the new rate and is usually then rounded to the nearest .125% increment. ARM loans typically have limits on how high an interest rate can rise at each adjustment period as well as over the life of the loan. These features are known as “caps” which help to protect the borrower from the risk of runaway interest rates in the future. In the event that interest rates rise, the caps help the borrowers to continue to afford their payments as their income is also expected to rise in the future, preventing “payment shock”.