Defintion of Adjustable Rate Mortgage

An Adjustable Rate Mortgage (ARM) is a loan where the interest rate is tied to an economic index. The interest rate of the loan fluctuates up or down during the term of the loan, depending on the agreed-upon index. The borrower is protected from intense fluctuations in the interest rate by applying a limit on how much the interest rate can change on an annual basis, as well as a lifetime cap, or limit, on changes in interest rates.

Lenders could offer several choices on the rates, terms, payments, or the adjustable period. However, the interest rate or better known as the qualifying rate, is set by the current rate of the chosen index.

After receiving the loan, the borrowers payment will remain the same for a specified period of time (6 months or a year) depending on the agreement with the lender. The lender then re-evaluates the loan to calculate a new payment based on the new rates.

The following are popular types of adjustable-rate mortgages Indexes:

Index Name Description
11th District Cost of Funds Index (COFI) Calculated from the interest rates paid on checking and savings accounts that are offered by financial institutions in the states of Arizona, California and Nevada.
12-month Treasury Average Index (MTA or MAT) This is a 12 month average of the monthly average yields of U.S. Treasury securities adjusted to a constant maturity treasury of one year (CMT – see below). Calculation: add the 12 of the most recent CMT values divided by 12.
London Interbank Offered Rate Index (LIBOR) A benchmark rate that is used by international banks when lending each other short-term loans. It is the first step to calculating rates on some loans across the world.
Constant-maturity Treasury Index (CMT) The weekly, monthly and annual CMT values are published by the U.S Treasury on a daily basis. The monthly one-year CMT value is a popular mortgage index which is used for many fixed period or hybrid ARMs