An adjustable rate mortgage (ARM) is a flexible type of mortgage with an interest rate that fluctuates based on an index. There are five types of indexes used to calculate the ARM interest rate. It is a common solution for financial institutions that cannot afford the risk of fixed loans, and it comes with caps on fees and borrower protection options. It is the most common type of mortgage offered by banks in Canada, the United Kingdom, and Australia.
An adjustable rate mortgage, also known as an ARM or variable rate mortgage, is a type of mortgage with a flexible interest rate. This means that the percentage rate fluctuates based on an index and adjusts to always benefit the lender, no matter how the market changes. Basically, there are five types of indexes used to calculate the adjustable rate mortgage interest rate. These are: the Constant Maturity Treasury (CMT), the District 11 Cost of Funds Index (COFI), the 12-month Average Treasury Index (MTA), the National Contract Average Mortgage Rate, and the Interbank Offered Rate of London (LIBOR).
An adjustable rate mortgage is a common solution for financial institutions that cannot afford the risk of fixed loans, such as banks financed solely by customer deposits, or for loan companies that offer a loan to people with no credit history, or those who request a fairly large loan. An adjustable rate mortgage is not necessarily a bad deal for the borrower, just riskier. In the event that the index falls, the borrower may end up paying less than they would with a normal home loan. In fact, an adjustable rate mortgage is the most common type of mortgage offered by banks in Canada, the United Kingdom, and Australia. Short-term loans can be fixed in these countries, but any loan or mortgage for more than ten years will normally take the form of an adjustable rate mortgage.
An adjustable-rate mortgage often comes with a cap or cap on fees, which controls how often or for a lifetime the interest rate changes. For example, an adjustable rate mortgage may be capped at a maximum of two percent per year, or a total of six percent over the life of the mortgage. This protects the borrower while ensuring a fairly secure transaction for the lender. Another type of borrower protection is taking a hybrid adjustable-rate mortgage, in which the interest rate only floats after a certain period of time, such as a year or so. This gives the borrower the opportunity to adjust her lifestyle enough to deal with the rate change without major consequences.
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