A Virtual World of Live Pictures.

An adjustable rate mortgage, or ARM, as it is popularly known, is a home loan. [1] in which the interest rate of the promissory note [2] is periodically adjusted based on a variety of indices [3]. Different lenders use different ratios to calculate their interest rates or adjustable rates. Some of the most commonly used indices are the 1-Year Constant Maturity Treasury (CMT), the Cost of Funds Index (COFI) and the London Interbank Offer Rate (LIBOR). However, some lenders prefer to use their own or personal indexes to determine rates. Lenders may choose to do this to take advantage of a constant margin from the borrower, and their own cost of financing is related to the index. As a result, the payments made by the borrower can also change over time in accordance with the resulting fluctuations in interest rates. Adjustable rate mortgages are generally characterized by their index and limitations on charges or caps. [4]. In many countries, adjustable-rate mortgages are the standard means of leveraging financing by offering the homes as securities, and in such cases the line of credit is simply called a mortgage.

Basic features of ARM or adjustable mortgage

The main features of ARM are:

  1. The initial interest rate
    It is the interest rate associated with the ARM at the time of the inception of the credit line. The initial ARM rate is generally well below current market ARM rates charged for years to come.
  2. The adjustment period
    This is the actual time period, of the total ARM loan period, that is scheduled to remain constant or unchanged. The interest rate resets at the end of the adjustment period and the monthly loan payment options are recalculated.
  3. Index rate
    Most lenders prefer to associate changes in ARM interest rates with changes that occur in a particular index. As noted above, lenders generally set ARM rates on a variety of indices. The most common index rate used is the one, three, or five-year Treasury Securities Index. Another index in common use is the national or regional average cost index of funds for savings and loan associations.
  4. Profit margin
    Earning is calculated by adding a certain percentage of the loan amount to the base index rate amount. The difference between the net loan amount due minus the base index amount is the actual profit the lender enjoys on an ARM.
  5. Adjustments and interest rates
    ARMs provide a one-time adjustment period for borrowers during the initiation of lines of credit. The fee structure may change at the end of the adjustment period. However, several lenders offer more than one adjustment period. Borrowers may change certain aspects of the net payable interest rates with each new adjustment period. Therefore, there is the advantage of taking advantage of different interest rates with individual adjustment periods. If the borrower knows the market, he can select different rates or interest rates and save money, as long as the lender agrees with the rates and rates.
  6. Initial discounts
    Initial discounts are concessions in interest rates and are very often used as promotional aids to attract clients for ARMs. These discounts are only offered during the first year of the ARM loan. Discounts help reduce the interest rate below the prevailing rate for a certain period of time so that the borrower can save some money through temporary reduced rates.
  7. Negative amortization[5]

    Ideally, the net interest rate receivable decreases with a regular monthly payment due against any credit loan. For mortgages, rates decrease over a period as loans are paid off. However, in the case of ARMs, the opposite is true, with the mortgage balance increasing each time the base ARM index rates rise. As the ARM base rate increases in magnitude, its associated interest amount and repayment limit also increase, and the borrower ends up paying a larger amount to redeem the loan. This is a negative feature of ARMs and the borrower may suffer some loss over the life of the loan until repayment occurs.

  8. Converting to a different loan format
    ARMs have an agreement whereby the borrower can convert the ARM to a fixed rate mortgage at specified times. This is often an alternative mechanism in case the ARM does not work in favor of the borrowers and the buyer wants to return to a safe option of a constant interest rate.
  9. Advance payment of the loan
    In most loans and credit facilities, lenders prefer that the borrower repay his installments as soon as possible to recover the original loan amount. However, in the case of ARM, an early payment can result in a potential loss to the lender in the long run. Therefore, lenders generally include a clause in the ARM agreement that may force the buyer to pay special fees or penalties in case the borrower decides to pay early. ARM prepayment terms are generally negotiated up front before the line of credit is tapped.


Although ARMs have a low initial interest rate, there is no indication that the future cost of borrowing will stay the same as the base index rate is likely to change. If the ratios go up, the net cost of ARM will also be higher and the borrower will have to pay a higher loan amount. Therefore, there is an inherent risk related to ARMs. Studies indicate that, on average, most borrowers who choose adjustable-rate mortgages save money in the long run.


[1] A mortgage loan is a specific type of loan, which is guaranteed by some property or a fixed asset value that has a certain financial value through a lien, or a legal commitment in writing that authorizes the creditor to sell the guarantee offered for recover the outstanding debt. , in case the creditor cannot pay or exchange the amount loaned. The word mortgage when used alone, in everyday life, is often used to refer to a home loan.

[2] A written promise to repay or redeem a certain amount of money borrowed, along with its interest at a predefined rate and period of time.

[3] An index rate is a widely used interest rate generally used by lenders to set the interest rate on loans and credit cards.

[4] Principal or loan amount.

[5] Amortization is a gradual reduction in the value of an asset or liability through some predetermined process. In the case of loans, it means a gradual or specific decrease in the magnitude of the amount of net interest to be paid over a period, until the total amount of the loan is canceled and considered paid.

Leave a Reply

Your email address will not be published. Required fields are marked *