Adjustable-Rate Mortgage (ARM): An adjustable-rate mortgage.
Adjustable-Rate Mortgage (ARM): An adjustable-rate mortgage, variable-rate mortgage or tracker mortgage is a mortgage loan with the interest rate that is periodically adjusted according an index which reflects the cost to the mortgage lender or bank of borrowing on the credit markets.
Fear of the Adjustable-Rate Mortgage
An adjustable-rate mortgage (ARM) usually falls into one of two categories: an interest-only ARM and the hybrid ARM.
Interest-only adjustable-rate mortgages offer an established period during which the homeowner only pays the interest on the loan, which effectively reduces the homeowner’s payment, but it leaves the principal outstanding.
Hybrid adjustable-rate mortgages, on the other hand, offer a fixed interest rate for an established period and then revert to a variable rate for the remainder of the loan’s life. A 3/1 ARM, for instance, is a mortgage that has a fixed rate for the first three years and then adjusts every year thereafter.
Often, adjustable-rate mortgages have caps – limits on how high and how low the interest rate can go, as well as how much they can shift in any one year, month, or quarter. In some cases, the interest rate will only adjust up, meaning the homeowner will get no benefit if interest rates fall.
According to the Consumer Financial Protection Bureau, “Many ARMs will start at a lower interest rate than fixed rate mortgages. This initial rate may stay the same for months, one year, or a few years. When this introductory period is over, your interest rate will change and the amount of your payment is likely to go up.
“Part of the interest rate you pay will be tied to a broader measure of interest rates, called an index. Your payment goes up when this index of interest rates increases. When interest rates decline, sometimes your payment may go down, but that is not true for all ARMs. Some ARMs set a cap on how high your interest rate can go. Some ARMs also limit how low your interest rate can go.”
Adjustable-rate mortgages can be intimidating for some homeowner given their volatility, but most experts agree that they are perfectly safe if homeowners exercise sound judgement.
“As long as borrowers are being realistic about how much house they can afford (the conservative rule-of-thumb is “no more than 2.5 times your annual income”), they should be perfectly safe taking out an adjustable-rate mortgage,” says Megan McArdle, the author of “The Up Side of Down: Why Failing Well Is the Key to Success.”