Real Estate Glossary > A > Adjustable Rate Mortgage Definition

A loan with a fixed interest rate The cost of borrowing money expressed as a yearly percentage rate. for a specified amount of time and a floating rate for the remainder of the period. The most common ARMs are for 5, 7, or 10 years. For example, a 30-year loan with a 5/1 ARM means that you'll pay a fixed interest rate for five years, then your rate will change each year after that for the next 25 years (or 60 payments). These rate changes will be based on an index such as the LIBOR (London Interbank Offered Rate) or COFI (Cost of Funds Index). These indices measure the cost for banks and lending institutions to borrow money from each other, which then affects the interest rate they charge borrowers. Most lenders will charge borrowers a rate based on an index, and then add a margin above this rate. This margin is usually expressed as the index LIBOR + 1%, or 2%, depending on the terms of the loan. ARMs can make financial sense if the borrower is planning to sell or refinance before the introductory period ends and the rate resets, or if she believe rates will be lower in the future. However, buyers should be aware that a rise in interest rates during the initial period may make it more difficult to refinance or sell when the time comes. See also fixed rate mortgage A loan with a set interest rate throughout the life of the loan regardless of whether rates go up or down. , conventional loan A mortgage loan not insured by any government program and follows guidelines set by the government-sponsored institutions Fannie Mae and Freddie Mac. , FHA Loan A loan with a low down payment and competitive interest rates that is insured by the Federal Housing Administration, a government agency that that provides funding for these loans from mortgage insurance payments. and VA loan A special type of loan backed by the government and only available to veterans of the US military and surviving relatives. .