adjustable rate mortgage
A mortgage with an interest rate that changes periodically based on a benchmark index, typically starting lower than fixed rates but carrying the risk of future increases.
Example
“The 5/1 ARM offered a low 4% rate for five years, then adjusted annually — fine if planning to sell within five years.”
Memory Tip
ARM = Adjustable Rate Mortgage. Starts low, could go up. Know your cap and how long you're staying.
Why It Matters
Understanding adjustable rate mortgages is crucial because they can significantly affect your monthly housing payments and long-term financial planning. If rates increase substantially, your payment could become unaffordable, making it essential to evaluate your risk tolerance and financial stability before committing to this type of loan.
Common Misconception
Many people believe that adjustable rate mortgages will always remain affordable because they start with lower initial rates. However, this initial rate period is temporary, and once it ends, your rate and payment can increase dramatically, potentially straining your budget if interest rates have risen in the market.
In Practice
A borrower might secure a 7-year ARM at 3 percent for the first seven years on a 300,000 dollar home, resulting in a monthly payment of about 1,265 dollars. After seven years, if the benchmark index has risen and the rate adjusts to 6 percent, that same loan could reset to a monthly payment of approximately 1,799 dollars, creating a sudden 534 dollar increase in their housing costs.
Etymology
ADJUSTABLE (changeable) RATE (interest percentage) MORTGAGE. A mortgage with an ADJUSTABLE interest RATE.
Common Misspellings
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Related Terms
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See Also
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