What is an Adjustable Rate Mortgage (ARM)?

An adjustable rate mortgage is a mortgage loan whose interest rate varies according to the indices based on which the rates are determined. Where the interest rate varies your payment liability also varies accordingly. Any change in the index rates will call for a change in the mortgage loan rate. While determining the rate applicable for a mortgage loan a percentage called the margin is added to the index rate which is usually the cost incurred by the lender and his profit margin. Through out the tenure of the loan this margin rate remains the same, while the basic interest rate keeps varying depending upon market rate and performance of the index.

In what way Adjustable Rate Mortgage Loan a Better Alternative?

Whether the mortgage loan sought after is a regular mortgage or a refinance mortgage, the nature of the loan depends upon its interest rate selection. It could be varying or fixed. Fixed rate mortgages (FRM) are normally higher than variable rate mortgage loans. Fixed mortgage loans have their interest fixed for the tenure of the loan and hence beneficial while analyzing the feasibility of the payment liability unlike variable interest loans which tend to change. Adjustable Mortgage Rates offer the benefit of lower interest rates atleast initially which you can use to save on the cost of loan.

As interest rates rise at a later point in time, it can be taken care by the salary hikes and other sources of funding available at a later date. Hence your liability is completely dependant upon the market performance. Borrowers also have the option of converting an ARM into an FRM, but the cost involved is heavy enough to wipe out the savings offered by an ARM.

ARM should not be confused with graduated payment method where the payment changes with a fixed interest rate. Mortgage Loan Calculators are available across websites which can used to determine the payment liability and thereby the feasibility of loan plans.

List down the ARM indices based on which the rates are subject to change

As indicated earlier, ARM is based on the certain indices and they are

• Cost of Funds Index (COFI)
• London Interbank Offered Rate (LIBOR)
• Constant Maturity Treasury Securities (CMT)

Are there interest caps on ARMS?

ARMs are normally indicated in the form of 1-1, 3-1 and 5-1, where the first number indicates the period of loan when the rates remain the same and the second number indicates the adjustment period, showing the periodicity of adjustments. There are caps on interest rates. Periodic Caps indicate the cap on interest change from one adjustment period to another and Overall Caps is a cap on the rate increase during the period of loan.

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