Adjustable Rate Mortgage (ARM)
What is an adjustable rate mortgage (ARM)?
An adjustable-rate mortgage or loan is a loan that is just that, adjustable. What’s adjustable? Usually, it is the interest rate, which is adjustable up and down at specific intervals. Some rules and regulations must be followed by an issuer of an adjustable rate mortgage or ARM.
How does an adjustable rate loan vary from a fixed rate loan?
A fixed-rate loan or mortgage is issued with a fixed interest rate for the life or term of the loan. Conversely, an adjustable rate loan has a rate that can change at specific time intervals. The rate charged is generally tied to a particular economic index, and as that index changes up and down as a result of economic activity, so to will the rate charged on an adjustable rate loan.
Why would a borrower select an adjustable rate loan?
Usually, an adjustable rate mortgage is issued with a lower initial interest rate than a comparable fixed-rate loan. This is the primary reason a borrower would select an ARM over a fixed-rate loan. Of course, if interest rates are expected to increase in the future, the fixed-rate mortgage may be a better choice, even though the fixed interest rate may be higher at issue than an ARM. Over the long term, the fixed-rate loan would be a better choice for a borrower, if interest rates do in fact increase.
Are there any downsides to an adjustable rate mortgage?
Yes. The biggest downside would be the potential that interest rates could increase tremendously over time. Of course, this would cause the rate charged on the ARM to increase over time. This increase in interest charged could be significant and cause the borrower to be unable to make their payments.
Where are ARMs issued?
They are originated in the primary mortgage market, which you can learn about in our article here.
Is private mortgage insurance required on an adjustable rate loan?
Possibly. If a borrower has less than 20% equity in an adjustable rate loan, the lender may require the purchase PMI or private mortgage insurance. You can learn more about PMI in our article here.
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