What is: Adjustable Rate Mortgage (ARM)

What is: Adjustable Rate Mortgage (ARM)

An Adjustable Rate Mortgage (ARM) is a type of mortgage loan where the interest rate can change periodically. This means that the monthly payments can go up or down depending on the market conditions.

ARMs typically have an initial fixed-rate period, after which the interest rate adjusts based on a specific index. Common indexes used for ARMs include the London Interbank Offered Rate (LIBOR) and the Constant Maturity Treasury (CMT) rate.

One of the main advantages of an ARM is that it often starts with a lower interest rate compared to a fixed-rate mortgage. This can result in lower initial monthly payments, making it an attractive option for borrowers who plan to sell or refinance before the rate adjusts.

However, there is also a risk involved with ARMs, as the interest rate can increase significantly after the initial fixed-rate period. This can lead to higher monthly payments and financial strain for borrowers if they are not prepared for the potential rate adjustments.

Borrowers considering an ARM should carefully review the terms of the loan, including the adjustment caps, margin, and index used to determine the interest rate. It is important to understand how the rate adjustments will impact monthly payments and overall affordability.

In summary, an Adjustable Rate Mortgage (ARM) offers flexibility with initial lower interest rates but comes with the risk of potential rate adjustments in the future. Borrowers should weigh the pros and cons of an ARM carefully before deciding if it is the right option for their financial situation.