Definition:
An adjustable rate loan (ARL) or adjustable rate mortgage (ARM) is a loan with an interest rate that fluctuates over time. This means that the interest rate on the loan can change periodically, typically based on a predetermined index or benchmark.
Key features of ARLs/ARMs:
- Initial fixed rate: ARLs often start with a fixed interest rate for a specified period, known as the initial fixed-rate period.
- Index: The interest rate on an ARL is typically tied to a benchmark index, such as the London Interbank Offered Rate (LIBOR) or the prime rate.
- Margin: The margin is the additional percentage added to the index to determine the ARL’s interest rate.
- Adjustment period: The frequency with which the interest rate adjusts is known as the adjustment period. This can be monthly, quarterly, annually, or at other intervals.
Why choose an ARL/ARM?
- Lower initial interest rate: ARLs often have lower initial interest rates compared to fixed-rate loans.
- Potential savings: If interest rates decline over time, ARLs can result in lower monthly payments.
Risks of ARLs/ARMs:
- Rising interest rates: If interest rates rise, ARL payments can increase significantly.
- Uncertainty: The fluctuating interest rates can create uncertainty and make it difficult to plan for long-term expenses.
When considering an ARL/ARM, it’s important to carefully evaluate the potential benefits and risks, and to choose a loan with an adjustment period and margin that aligns with your financial goals and risk tolerance.
