An Adjustable Rate Mortgage (ARM), is a type of mortgage in which the interest rate can change throughout the life of the loan.
• All ARMs have a base rate called the index; a markup to that rate called the margin; and when added together give you the fully indexed rate. This is the rate you pay.
Index + Margin = Rate.
• Most ARMs come with two types of rate caps:
1. Periodic Rate Caps which limit how much the interest rate can change from one period (year) to the next
2. Lifetime Rate Caps which limits how much the interest rate can go up over the lifetime of the loan.
• ARMs also have floor limits which provide the lowest rate they can go down.
• Some ARMs have convertibility options which allow you to fix the rate after a set time. While fixed rates carry the same interest rate for the life of the loan, like on a 30-year fixed rate, they may have higher interest rates as opposed to ARMS in the short term. At the same time, fixed-rate loans provide the assurance that the borrower’s rate will never go up.
• So why consider an ARM? An ARM can help cut costs over the short term for buyers knowing they might be wanting to relocate as with an expanding family or someone who knows they will be transferred by their employer.
• Some ARMs offer interest only options like on Home Equity Lines of Credit (HELOC).
• And unlike fixed rate loans where the payment always remains the same, ARMs can adjust the payment downward at the end of each adjustment period, if you prepay the principal balance.