An adjustable rate mortgage, or ARM, is a type of home loan where the mortgage interest rate is not fixed and fluctuates over time based upon some pre-determined external index. The most commonly used indices are the 1-year Constant Maturity Treasury bill, the Cost of Funds Index (COFI), or the London Interbank Offered Rate (LIBOR), though other indices can be and are used. With an adjustable rate mortgage loan, if the external index goes up, the mortgage index rate will also go up, leading to higher monthly mortgage payments. Most adjustable rate mortgages feature a cap, or safety feature, to limit the amount your mortgage interest rate may increase periodically, as well as over the life of the loan.
Adjustable rate mortgages offer the borrower slightly reduced initial payments in exchange for assuming the risk of future market fluctuations and should never be entered into lightly. Some adjustable rate mortgages offer an initial "teaser" period at substantially reduced interest rates; after the specified period, usually one year, the mortgage interest rate moves into alignment with the external index. Although theoretically capable of saving a borrower some funds during the specified period, "teaser" rates usually lead to future financial problems or even the foreclosure of your home. The most important question is: Are the temporary interest savings worth risking the ownership of home?