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What is an ARM?

"ARM" is an acronym for Adjustable Rate Morgage. In an ARM, the interest rate can adjust according to a pre-set schedule, which means that your monthly payment on an ARM can go up or down.

An ARM may have an initial period within which the interest rate stays fixed -- ARMs come in the following flavors:

1 month ARM
6 month ARM
2 year ARM (also called a 2/28")
3 year ARM
5 year ARM

Generally, the longer the initial fixed interest rate period, the higher your interest rate is.

Here's how all mortgages are built

All mortgages are built of three main pieces:

  1. A financial index (like the Prime Rate, the Monthly Treasury Average, or LIBOR)
  2. A margin (which represents the bank's profit)
  3. A fudge factor that accounts for how long you want the interest rate fixed

Let's show a couple of examples:

Flavor Financial Index Margin Fudge Factor Interest Rate
Five year ARM 6 month LIBOR 4.04% 2.25% 0.15% 6.44%
Home Equity Line of credit ("HELOC") Prime Rate 6.50% 0 Zero - there is no fixed period in a HELOC 6.50%
Option ARM 1 month LIBOR 3.588% 2% Zero - no fixed period 5.588%
30-year fixed 10 year Treasury 4.17% Mixed together; combined 2.35% 6.52%

 
(c) 2005 by Accredit Mortgage, LLC