ARM Terminology

Adjustable Rate Mortgages, or ARMs, have their own set of terms and phrases that are commonly used by lending professionals. Understanding what these terms mean isn’t difficult, and can be very helpful when figuring out whether you are interested in an ARM, and if so, what type of ARM is best for you.

The first ARM term we will discuss is the index. The index is the guide used by your lender to determine how interest rates are changing. As you know, the primary feature of ARMs is that the rate is adjustable, or can be changed by the lender. However, these rates are not raised or lowered at random. Each ARM is linked to a specified index, which is used to figure out what the change will be. Commonly used indexes are Treasury securities of the one-year, three-year, or five-year variety. Certificates of Deposit (CDs) can also be used for shorter-term ARMs.

The next term we will consider is margin. Margin can be most easily thought of as the mark-up added by the lender. The margin represents both the lender’s business expenses and the profit the lender will make on the loan. The lender adds the margin to the index rate to determine the interest rate for you, the consumer. While your rate will change throughout the life of your ARM, the margin usually stays constant.

The final term to discuss is the adjustment period. The adjustment period represents the time between potential rate changes. ARMs come with a variety of adjustment periods, usually quoted in the name of your specific loan (examples include three year ARMs, twelve month ARMs, and six month ARMs).

Keep these terms in mind when considering an ARM, and you will have an advantage in making your decision.