Identification

• The general economy and interest rate environment influence ARM rates. Rates generally increase as the economy and loan demand improve. Conversely, interest rates fall with weak loan demand.
  
  

Features

• ARMs offer variable interest rates based upon an underlying benchmark, such as one-year Treasury bills or the London Interbank Offered Rate (LIBOR). Creditors add an interest rate spread, or ARM margin, to the benchmark to calculate your ARM rate.
  
  

Example

• For example, your credit terms may call for a 2 percent spread over one-year Treasury rates. If the one-year Treasury benchmark is 5 percent, your ARM rate is now 7 percent.
  
  

Considerations

• Banks set individual ARM spreads and interest rates according to risk. Banks demand higher ARM interest rates to finance investment properties and less creditworthy borrowers.
  
  

Misconceptions

• Contrary to popular belief, ARMs do install safeguards to protect borrowers. ARM terms carry rate ceilings, which cap rates from rising dramatically alongside underlying benchmarks.
  
  

Risks

• ARM payments may increase steadily over time. Increasing adjustments may make your mortgage unaffordable and expose you to foreclosure.