Adjustable Rate Mortgage (ARM)

Financial Dictionary -> Mortgages -> Adjustable Rate Mortgage (ARM)

An Adjustable Rate Mortgage, or ARM in its shortened form is a loan to purchase a house just like any other mortgage, but the interest rate of repayment fluctuates. To put it simply the mortgage interest rate changes in relation to the market place and interest rates in general, instead of being fixed, hence it being called an Adjustable Rate Mortgage. They will always be linked to at least one index to base its rate on. Because of the fluctuations they are hard to predict and are relatively risky form of mortgage to enter in to.

The main benefit of obtaining an Adjustable Rate Mortgage is that you could end up with a significantly lower interest rate than you would if you were on fixed rate terms. However if you don't do your research or at least hire somebody who understands the economy then in the long run you could end up with a considerably high interest rate, which you may not be able to pay back. In the right circumstances the Adjustable Rate Mortgage is a great choice to make, but you need to be well informed.

All available Adjustable Rate Mortgage loans are not automatically adjusted however they might not always reflect obvious changes in interest rates. They are based on several indices, including the Cost Funds Index and the London Interbank Offered Rate.

Some lenders even use their own cost of funds as an index and therefore make sure the odds are in their favor over the long run, with a usual increase every year. Don't be fooled by low rates to begin with, they may catch up to you in the end. It is also important to understand "initial discounts" which start the mortgage below the normal rate, only to match it to the index the after the first few years. You should at least know the real rates before entering in to this type of mortgage.

A lot of lenders also offer what is called a conversion. In certain circumstances this allows you to convert from an Adjustable Rate Mortgage to one with fixed terms for better security and stability.