Also referred to as a variable rate or floating rate mortgage, an ARM is a residential mortgage in which the interest rate floats up or down based on market conditions which affect the margins and indexes the loan is tied to.
The flucuation of a variable rate mortgage’s interest rate is usually in response to changes in the Treasury Bill rate or the prime rate. The purpose of the interest rate adjustment is primarily to bring the interest rate on the mortgage inline with market rates. The mortgage holder is protected by a maximum interest rate (called a ceiling), which may be reset annually. ARMs usually start with better rates than fixed rate mortgages, in order to compensate the borrower for the additional risk that future interest rate fluctuations will create.