A variable-rate mortgage, also known as an Adjustable-Rate Mortgage (ARM), has an interest rate that changes periodically depending upon a corresponding index. As the interest rate changes, the borrower’s combined monthly payment of interest and principal will increase or decrease.
ARM loans are quoted by the length of time the interest rate remains the same and how often it changes. For example, a loan quoted as 7y/6m means that the interest rate is fixed for the first seven (7y) years of the loan and then subject to change every six (6m) months after that.
Example ARM Terms and Calculations
John buys a house for $250,000 with $50,000 cash and borrows the remaining $200,000 from a bank. The bank gives John a 10y/6m adjustable-rate mortgage for a 30-year term.
The initial interest rate on the loan is 7% and will remain at 7% for the first 120 payments (10 yrs X 12 payments). After the first ten years, the interest rate is adjusted up or down every six months. The mortgage also provides that the lifetime rate cap is 12%, meaning the interest rate on the loan can never exceed 12%.
John’s initial monthly payments for the first ten years are $1,331. If, for example, after the first ten years the interest rate increases from 7% to 8.125%, John’s monthly payment increases to $1,449.
Additional Information
Homebuyers can learn more about adjustable rate mortgages by visiting the Consumer Financial Protection Bureau (CFPB) website.