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What is an ARM?
"ARM" is an acronym for Adjustable Rate Morgage. In an ARM, the interest rate can adjust according to a pre-set schedule, which means that your monthly payment on an ARM can go up or down.
An ARM may have an initial period within which the interest rate stays fixed -- ARMs come in the following flavors:
| 1 month ARM | 5 year ARM |
| 6 month ARM | 7 year ARM |
| 2 year ARM (also called a "2/28") | 10 year ARM |
| 3 year ARM |
Generally, the longer the initial fixed interest rate period, the higher your interest rate is.
Statistics show that very few people keep a mortgage longer than seven years. If you're not certain that you'll be in your current home longer than that, you might consider using an ARM with a fixed rate period that will cover the amount of time you think you'll be there -- but not paying for a guarantee that your interest rate will be the same 27 years from now, for example.
Here's how all mortgages are built
All mortgages are built of three main pieces:
- A financial index (like the Prime Rate, the Monthly Treasury Average, or LIBOR)
- A margin (which represents the bank's profit)
- A fudge factor that accounts for how long you want the interest rate fixed
Let's show a couple of examples:
| Flavor | Financial Index | Margin | Fudge Factor | Interest Rate |
| Five year ARM | 6 month LIBOR 4.49% | 2.25% | 0.15% | (call for update) |
| Home Equity Line of credit ("HELOC") | Prime Rate 7% | 0 | Zero - there is no fixed period in a HELOC | (call for update) |
| Option ARM | 1 month LIBOR 4.368% | 2% | Zero - no fixed period | (call for update) |
| 30-year fixed | 10 year Treasury 4.51% yield | Mixed together; combined 2.35% | (call for update) | |