What is an ARM Home Loan?

Every ARM comes along with a permanent margin and is connected to a major mortgage index such as The Cost of Funds Index (COFI), Monthly Treasury Average (MTA), or London Interbank Offer Rate (LIBOR). While some banks and lenders allow you select an index, many will opt to rely on just one of the major indexes for their products.

In the years leading up to the housing crisis of 2008, ARMs were essentially all sub-prime loans; however ARMs aren’t all instruments of evil, in fact, todays hybrid ARMs can prove to be quite advantageous to the consumer. Prior to the housing crisis, adjustable mortgage rates were often times options, which allowed for an increase in the principal balance of the loan when homeowners failed to make payments. These days ARMs are much more soundly regulated by lenders who properly qualify potential candidates, as opposed to the previous predatory practices that were commonplace in the mortgage business before the big collapse.

ARMs typically have an initial period, during which the interest rate is fixed; after the initial period ends, the rate adjusts to its fully indexed rate, which can be calculated by adding the margin to the index.  You can easily obtain the current index price online and should be able to find the margin you agreed to within your loan paperwork. Additionally, you’ll need to figure in the payment caps in order to accurately see how often your loan will actually adjust. ARMs can go up, down, or stay the same as their rates are predicated by the major indexes. ARMs can get a bit scary in the long run, but can also prove to be extremely beneficial when you’re able to score a low monthly payment.



Many people neglect to scrutinize the margin- BIG mistake. Margins sometimes vary by over 1% depending on the lender, which can have a substantial effect on your mortgage payment. It behooves the buyer to inquire about the margin and thoroughly explore all options in order to find the lowest interest rate by finding a bank offering a lower margin.

Another crucial element of the ARM loan to consider is the interest rate cap. ARM caps are there to limit rate movement so that the borrower doesn’t experience an astronomical shift in their payment when the rate adjusts. There are three types of caps: the initial cap, which limits the adjustment rate after the fixed term concludes; the periodic, which dictates how much a rate can change during each adjustment period; and lifetime cap which as you can imagine, governs how much your rate can shift over the entire lifetime of the loan.




With ARMs, consumers are able to find lower interest rates. Many times, the rate during the initial period is considerably lower than alternative fixed-rate options.  After the initial period ends, and the rates adjust, many consumers will refinance, get themselves into another ARM, or simply sell the home outright. With ARMs it’s all about understanding when to make the right move, and having a full accounting of your situation to execute the most advantageous course of action.