The key letter in ARM is A, and it stands for adjustable, as in Adjustable Rate Mortgage.
Most mortgages have a fixed interest rate. That means you pay 5% interest (or whatever your rate is) during the first year you have your mortgage, during the third year, and all the way to the final day you have that loan and can throw your big ""We Paid it Off"" party.
With an adjustable rate mortgage, your rate can change. Why would you want to get an ARM rather than a fixed rate mortgage? Well, maybe you like the element of surprise. More likely, you can save a few bucks at the start of the mortgage loan. If interest rates are expected to rise, you can get a better rate (at first) with an ARM than you can with a fixed rate mortgage. By the time your ARM rates go up and you have to pay more, maybe you'll have gotten that promotion at work.
Lots of folks choose ARMs, because they seem like a better deal on paper, but you'll want to run side-by-side comparisons to figure out whether they'll cost you more in the long run. You'll also want to make sure you can afford your home loan—even if interest rates go up. If you're just barely making payments now and your monthly mortgage costs go up $300, what are going to do? That's the sort of situation that causes people to lose their homes.
ARMs have a couple parts. They usually start with a low interest rate and have a guaranteed period of time for that interest rate, so you know your interest rate won't go up right away. An ARM also usually comes with an index (like LIBOR) against which it is adjusted, a step up percentage (how much the interest rate will likely grow each period), and maybe a cap (the maximum rate it can be raised in a given period). That all ensures that the rate won't balloon out of control.
Some ARMs are interest-only for the first few years. The monthly amount you pay is really low, but you're also not paying down the principal or the amount you borrowed. Which means the total amount you owe to the bank is not going down any. The upside is that your payments will be affordable at first, and you'll have time to increase your income or get a great job (and hopefully give interest rates a chance to drop).
Related or Semi-related Video
Finance: What is Adjustable Rate Preferr...15 Views
Find it a la shma What is adjustable rate preferred
stock Okay let's start with the basics preferred stock and
yes we have a whole video on this one as
well Preferred stock generally pays a dividend and is often
convertible into common stock at a premium to where it
was issued So preferred stock is kind of bond like
and kind of equity Like fish Most preferred stocks get
issued some set dividend like a base rate of say
six percent or something like that And note that it's
called a dividend in the case of preferred stock not
an interest payment subtle but very important difference here because
interest on bonds is tax as ordinary income and dividends
on equities are qualified meaning that their tax at long
term gains rates or dividend tax rates anyway these preferred
pay six percent no matter what the price at which
one preferred unit trades will fluctuate like a stock or
bond But that thousand dollars par preferred will just continue
to pay its sixty bucks a year in dividends until
the preferred shares are bought back by the company you
know at some premium or until the shares convert into
being common stock or the company goes bankrupt in armageddon
scenario one starring ben affleck jr But in the case
of adjustable rate preferreds it's not always the six percent
that gets paid or whatever the initially stated rate wass
in the case of these equities and yes preferred stocks
considered equity even though it acts like a bond Sometimes
in this case the dividends will very with some set
indexed like t bills or live or where the preferred
dividend might be set on a say a trailing four
quarter bases to be two hundred basis points Mohr interest
that it pays than the average t bill reign as
of blah blah blah blah time frame Well why would
you want this adjustable feature with preferreds Well you can
imagine a scenario in a low interest rate environment where
we have preferred stocks paying five percent and the prevailing
rates are three percent for very high quality dead teo
top notch blue chip companies But then we get inflation
and that three percent for the best borrowers goes to
six percent and a given preferred stock would then need
to pay more like eight percent to be trading around
The thousand dollars par value it was issued at So
said another way if that piece of paper is on
ly giving investors fifty bucks a year when a very
similar piece of paper gives investors eighty bucks a year
investors will want charity They will sell down than thousand
dollar piece of paper giving only fifty bucks to price
low And so that when it's bought it pays eighty
bucks a year in charity right that thousand dollars going
to sell down to nine hundred eight hundred seven hundred
until whatever you pay for it pay the same interest
rate is that eighty dollars year thing Thank you Inflation
specifically In this case a thousand dollars preferred paying fifty
bucks a year would have to sell for six hundred
twenty five bucks teo yield eight percent meaning that the
thousand dollars par value that investors bought in a five
to ten years ago would drop dramatically by three hundred
seventy five dollars a unit to be six hundred twenty
five dollars To be quote at market unquote and that's
a problem a big risk that investors will hate Hence
the invention of the adjustable feature here Adjustable rate preferred
Stock Great inventions So in this case if it preferred
was adjustable if rates went up a cz were describing
here then it is extremely likely that the t bill
or live or rates would go up similarly as they
generally follow inflation grids over time And in this scenario
if the rate of the dividend on the preferred stock
at just's then it's always going to be something like
t bill ray plus three hundred basis points or something
like that so that if there really is big inflation
and federal funds rates go from three percent to six
percent The return on these preferreds would go up about
the same amount making the security much more appealing to
investors Got all that well let's Just hope that if
anything else is in need of getting adjusted those investors
will take care of it in private nia do that
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