How Do Adjustable Rate Mortgages (ARM) Work?


Welcome to the Investors Trading Academy talking
glossary of financial terms and events. Our word of the day is “ARM – Adjustable
Rate Mortgage” ARM is an acronym for adjustable rate mortgage,
a type of mortgage in which the interest you pay on your outstanding balance rises and
falls based on a specific benchmark. ARMs usually start out at a fixed rate for a short
period of time, and then the rate resets annually based on the benchmark, plus an additional
amount. The initial interest rate is normally fixed for a period of time after which it
is reset periodically, often every month. The interest rate paid by the borrower will
be based on a benchmark plus an additional spread, called an ARM margin.
An adjustable rate mortgage is also known as a “variable-rate mortgage” or a “floating-rate
mortgage”. For example, if you have a five-year ARM,
you will have a set rate for the first five years. Then the rate will change based on
the terms of your mortgage. This means your monthly mortgage payment may start out low,
but then rise after the fixed-rate period is over.
Both 2/28 and 3/27 mortgages are examples of ARMs. A 2/28 mortgage’s initial interest
rate is fixed for a period of two years and then resets to a floating rate for the remaining
28 years of the mortgage. A 3/27 mortgage is typically the same as a 2/28 mortgage,
except that the interest rate is fixed for three years and then floats for the remaining
27 years of the mortgage.

Paul Whisler

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