What is an Adjustable Rate Mortgage?

An adjustable rate mortgage (ARM) is a mortgage loan where the interest rate on the mortgage note is periodically adjusted based on an index. The most common indices used are the one (1) year Treasury or constant maturity Treasury (CMT), the Cost of Funds Index (COFI) and the Libor Index or London Interbank Offered Rate. These indices are used to ensure a steady margin for the mortgage lender. Therefore, payments made by the borrower may change over time with the changing interest rate tied to the index. The use of Adjustable rate mortgage loans transfer part of the interest rate risk from the mortgage lender to the borrower. By obtaining an adjustable rate mortgage loan the borrower benefits if the interest rates stay low or falls, but loses if the interest rates keep going up or increases.

About ARM loans

Adjustable rate mortgages (ARMs) are basically short-term fixed rate mortgage loans due to the fixed rate periods between change dates. When the Adjustable rate mortgages rate is adjusted, the mortgage lender uses the current value of the Index used on the mortgage note and adds a percentage markup which is known as the Margin.

Adjustable rate mortgages (ARMs) are setup with a rate formula for the mortgage loans, which are usually priced by using the loans index then adding the margin. Most loans have a starting rate which is usually a teaser rate which is an incentive for the borrower to take the loan. Basic Formulas is the Loan Index + Loan Margin = Note Rate that will be charged for the next adjustment period.

Adjustable rate mortgages (ARMs) come in several varieties, but basically they all work the same way. At the end of the fixed period, the interest rate is changed in accordance with the value of an identified gage, called the index.

Adjustable rate mortgages (ARMs) come with rate caps where payments made by the borrower may increase a certain amount over time and to limit the risk there are limits on charges known as rate caps.

Adjustable rate mortgage loans are branded by the index used on the mortgage loan.

Adjustable rate mortgage loans all have adjusting interest rates that are tied to an index.

Adjustable rate mortgage loans all have a rate formula used on the rate changes (Margin).

Adjustable rate mortgage loans all have limitations on the rate changes (Rate Caps).

Indexes

While there are many indexes used to base Adjustable rate mortgages, the most popular types and the most common indices in the United States are:

  • 11th District Cost of Funds Index (COFI)
  • London Interbank Offered Rate (LIBOR)
  • 12 month Treasury Average Index (MTA)
  • Constant Maturity Treasury (CMT)

Treasury Constant Maturities (aka TCM): This is the most common Index used on one-year ARMs.

Treasury Bills (T-Bills): This index mostly used for three month ARMs and six month ARMs.

11th District Cost of Funds (COFI): used mainly on one month ARMs and six month ARMs.

London InterBank Offered Rate (LIBOR): This index is used mainly on one month ARMs and six month ARMs.

Basic Features of ARMs

The most important basic features of ARMs are:

Interest Rate (Initial): This is the starting interest rate or teaser interest rate on an ARM loan that is given at the start of the mortgage loan.

Adjustment Period: This is the length of time that the interest rate or period of an ARM loan is scheduled to remain unchanged. The rate is changed and reset at the end of this period and the monthly loan payment is recalculated.

Index Rate: All ARM loans have an index that the loan is based and the interest rate changes are tied to the changes in the index rate.

Margin: This is the percentage amount that the mortgage lenders add to the current index rate to determine the Arm’s adjusted interest rate.

Interest Rate Cap: Are the limits on how much the interest rate can be changed at the end of each adjustment period or over the life of the mortgage loan.

Negative Amortization: This occurs whenever the monthly mortgage payments are not enough to pay all the interest due on the mortgage note. This is caused when the payment contained in the ARM is not enough such that the principal and interest payment is more than the payment made.

Conversion: The agreement in a mortgage loan where the mortgage lender may have a clause that allows the buyer to convert the ARM to a fixed rate mortgage at a designated date.

Rate Caps

To protect consumers from big interest rate increases most ARMs have some form of limitations on how much the interest rate can move from fixed period to fixed period. These limitations are called "caps" or "rate caps".

Caps typically apply to three characteristics of the mortgage loan:

  • Frequency of the interest rate change
  • Periodic change in the interest rate
  • Total change in interest rate over the life of the loan

What is an Adjustable Rate Mortgage?

An adjustable rate mortgage (ARM) is a mortgage loan where the interest rate on the mortgage note is periodically adjusted based on an index. The most common indices used are the one (1) year Treasury or constant maturity Treasury (CMT), the Cost of Funds Index (COFI) and the Libor Index or London Interbank Offered Rate. These indices are used to ensure a steady margin for the mortgage lender. Therefore, payments made by the borrower may change over time with the changing interest rate tied to the index. The use of Adjustable rate mortgage loans transfer part of the interest rate risk from the mortgage lender to the borrower. By obtaining an adjustable rate mortgage loan the borrower benefits if the interest rates stay low or falls, but loses if the interest rates keep going up or increases.

About ARM loans

Adjustable rate mortgages (ARMs) are basically short-term fixed rate mortgage loans due to the fixed rate periods between change dates. When the Adjustable rate mortgages rate is adjusted, the mortgage lender uses the current value of the Index used on the mortgage note and adds a percentage markup which is known as the Margin.

Adjustable rate mortgages (ARMs) are setup with a rate formula for the mortgage loans, which are usually priced by using the loans index then adding the margin. Most loans have a starting rate which is usually a teaser rate which is an incentive for the borrower to take the loan. Basic Formulas is the Loan Index + Loan Margin = Note Rate that will be charged for the next adjustment period.

Adjustable rate mortgages (ARMs) come in several varieties, but basically they all work the same way. At the end of the fixed period, the interest rate is changed in accordance with the value of an identified gage, called the index.

Adjustable rate mortgages (ARMs) come with rate caps where payments made by the borrower may increase a certain amount over time and to limit the risk there are limits on charges known as rate caps.

Adjustable rate mortgage loans are branded by the index used on the mortgage loan.

Adjustable rate mortgage loans all have adjusting interest rates that are tied to an index.

Adjustable rate mortgage loans all have a rate formula used on the rate changes (Margin).

Adjustable rate mortgage loans all have limitations on the rate changes (Rate Caps).

Indexes

While there are many indexes used to base Adjustable rate mortgages, the most popular types and the most common indices in the United States are:

  • 11th District Cost of Funds Index (COFI)
  • London Interbank Offered Rate (LIBOR)
  • 12 month Treasury Average Index (MTA)
  • Constant Maturity Treasury (CMT)

Treasury Constant Maturities (aka TCM): This is the most common Index used on one-year ARMs.

Treasury Bills (T-Bills): This index mostly used for three month ARMs and six month ARMs.

11th District Cost of Funds (COFI): used mainly on one month ARMs and six month ARMs.

London InterBank Offered Rate (LIBOR): This index is used mainly on one month ARMs and six month ARMs.

Basic Features of ARMs

The most important basic features of ARMs are:

Interest Rate (Initial): This is the starting interest rate or teaser interest rate on an ARM loan that is given at the start of the mortgage loan.

Adjustment Period: This is the length of time that the interest rate or period of an ARM loan is scheduled to remain unchanged. The rate is changed and reset at the end of this period and the monthly loan payment is recalculated.

Index Rate: All ARM loans have an index that the loan is based and the interest rate changes are tied to the changes in the index rate.

Margin: This is the percentage amount that the mortgage lenders add to the current index rate to determine the Arm’s adjusted interest rate.

Interest Rate Cap: Are the limits on how much the interest rate can be changed at the end of each adjustment period or over the life of the mortgage loan.

Negative Amortization: This occurs whenever the monthly mortgage payments are not enough to pay all the interest due on the mortgage note. This is caused when the payment contained in the ARM is not enough such that the principal and interest payment is more than the payment made.

Conversion: The agreement in a mortgage loan where the mortgage lender may have a clause that allows the buyer to convert the ARM to a fixed rate mortgage at a designated date.

Rate Caps

To protect consumers from big interest rate increases most ARMs have some form of limitations on how much the interest rate can move from fixed period to fixed period. These limitations are called "caps" or "rate caps".

Caps typically apply to three characteristics of the mortgage loan:

  • Frequency of the interest rate change
  • Periodic change in the interest rate
  • Total change in interest rate over the life of the loan
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