ARM

A home loan with an interest rate that adjusts periodically based on a benchmark index.

An Adjustable-Rate Mortgage (ARM) is a home loan with an interest rate that fluctuates over time, typically after an initial fixed-rate period. The rate adjustments are tied to a benchmark financial index, meaning the borrower's monthly payments can rise or fall in tandem with broader market interest rates. This contrasts with fixed-rate mortgages, where the interest rate remains constant for the entire life of the loan. For investors, tracking the share of ARM applications provides valuable insight into consumer behavior, housing affordability, and credit risk. When fixed mortgage rates are high, buyers often turn to ARMs to secure lower initial payments, though this exposes them to payment shock if interest rates continue to rise. A high concentration of ARMs in the mortgage market can increase systemic risk during periods of rising interest rates, as borrowers face higher monthly obligations that can lead to increased default rates. When evaluating ARMs, investors and analysts look at the spread between fixed-rate mortgages and initial ARM rates, as well as the index and margin used to calculate adjustments. Common benchmarks include the Secured Overnight Financing Rate (SOFR) or the Constant Maturity Treasury (CMT) rate. Most ARMs also feature caps that limit how much the interest rate can increase during any single adjustment period and over the lifetime of the loan.

A homebuyer takes out a 5/1 ARM for $400,000. For the first 5 years, the interest rate is fixed at an initial rate of 4.5%. In year 6, the rate adjusts based on a benchmark index (SOFR) of 3.0% plus a margin of 2.0%. The new interest rate for that year becomes 3.0% + 2.0% = 5.0%, which increases the borrower's monthly payment.