Adjustable-Rate Mortgage (ARM)
Definition
An adjustable-rate mortgage (ARM) has an interest rate that changes periodically based on market conditions, typically after an initial fixed-rate period. The rate adjustment is tied to a financial index plus a margin.
Example
A borrower gets a 5/1 ARM at 5% initial rate with a 2% periodic cap and 6% lifetime cap, margin of 2.5%. After 5 years, if the index is 4%, the new rate would be 4% + 2.5% = 6.5%. But the periodic cap limits the increase to 7% (5% + 2%). The rate can never exceed 11% (5% + 6% lifetime cap).
Exam Tip
Know the components: Index + Margin = Fully Indexed Rate. Understand the three types of caps: periodic (per adjustment), lifetime (total increase), and payment cap. A common exam question: "What is the maximum rate?" Answer: Initial rate + lifetime cap. The margin stays the same throughout the loan.
Related Financing Terms
Deed (in foreclosure context)
In the context of foreclosure, a deed transfers ownership of the foreclosed property to the new owner, typically the buyer at a foreclosure sale.
Trustee Sale
A trustee sale is a type of foreclosure where a trustee, appointed under a deed of trust, sells the property at auction to satisfy the debt.
Foreclosure
Foreclosure is the legal process by which a lender takes possession of a property when a borrower fails to make mortgage payments. It allows the lender to sell the property to recover the outstanding debt.
Conventional Loan
A conventional loan is a mortgage that is not insured or guaranteed by a government agency such as the FHA, VA, or USDA. It is originated and funded by private lenders and may be conforming or non-conforming.
FHA Loan
An FHA loan is a mortgage insured by the Federal Housing Administration that allows lower down payments and credit scores than conventional loans. It is designed to help first-time homebuyers and borrowers with limited resources.
VA Loan
A VA loan is a mortgage guaranteed by the Department of Veterans Affairs available to eligible veterans, active-duty service members, and surviving spouses. It offers no down payment and no private mortgage insurance requirements.
Frequently Asked Questions
Test Your Financing Knowledge
Practice with exam-style questions to make sure you can apply Adjustable-Rate Mortgage (ARM) and other financing concepts.