What is an ARM?
"ARM" is an acronym for Adjustable Rate Morgage. In an ARM, your interest rate is fixed for a specified period of time (like 2 years, 5 years or as little as one month), after which it can go up or down with market conditions. When your interest rate goes up, so does your payment (this is why some people are wary of ARMs.)
ARMs are built around the fact that very, very few people keep their mortgages for a full 30 years -- we move and we refinance our homes when our lives' situations change. Since it costs more money to fix an interest rate for 30 years, it makes sense to ask:
"How long do I know I'm going to be in this mortgage?"
How long will you live in this home, for sure? Remember, choosing a 30 year fixed interest rate costs you more every day when compared to an ARM in its initial fixed rate period. In a sense, getting a 30 year fixed rate mortgage is like betting against the universe that you'll be in your home for a long time.
If you look at your life, your job, your marital status, the number of kids you have now (vs. the number that you may have several years from now) you may start to feel unsure about staying in your home for 30 years. Perhaps a shorter period of time would be a safer bet.
With an ARM, you get to choose for what period of time you'd like your interest rate to stay fixed. Here are some of the choices you have:
| 1 month ARM |
| 6 month ARM |
| 2 year ARM (also called a "2/28") |
| 3 year ARM |
| 5 year ARM |
Generally, the longer the initial fixed interest rate period, the higher your interest rate is.
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 -- "MTA" -- or LIBOR)
- A margin (which represents the bank's profit)
- A fudge factor which 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 5.354% | 2.25% | -1.729% | 5.875% |
| Home Equity Line of credit ("HELOC") | Prime Rate 8.250% | 0 | Zero - there is no fixed period in a HELOC | 8.250% |
| Option ARM | 1 month LIBOR 5.32% | 2.20% | Zero - no fixed period | 7.520% |
| 30-year fixed | 10 year Treasury 4.670% | Mixed together; combined 1.33% | 6.000% | |
Quick interest rates
| Program | Rate | APR |
| 30 year fixed | 6.375% | 6.623% |
| Jumbo fixed 30 | 8.500% | 8.652% |
| 5 year ARM | 5.750% | 6.159% |
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