In a very simple language, an ARM can be defined as, a mortgage loan that has a variable rate of interest, which is decided on the basis of benchmarks that are set by different economic indexes. The adjustable rate works just like other mortgage loans.

The only difference is that the rate of interest on periodic installments changes the total amount of installments that is to be paid. Usually the first few installments that are paid have a congruent rate of interest. However, according to the promissory note of the ARM, the rate of interest is later on changed, in accordance with the said index.

The rate of interest of such mortgages can be changed as often as every month. The ARM is also known as 'variable rate mortgage' or 'floating rate mortgage'.

According to the ARM definition, the interest rate that is paid along with every installment of mortgage, is based upon some or the other economic index. In United States of America, there are six primary indexes that are used by the lenders, in order to set the rate of interest on a particular ARM.

The adjustable mortgage rates, thus basically depends on the type of index that is being followed, and the amount that is payable to the lender. Here's a small illustration that shall prove to be explanatory...

In case if you are wondering which mortgage to choose, you may consult the guidelines that are issued by government agencies, Federal Reserve Board and Federal Home Loan Bank Board. These agencies have also prepared a mortgage checklist for the buyers and borrowers of mortgage loans, so as to help them to understand the concepts and basics of ARM.

The only difference is that the rate of interest on periodic installments changes the total amount of installments that is to be paid. Usually the first few installments that are paid have a congruent rate of interest. However, according to the promissory note of the ARM, the rate of interest is later on changed, in accordance with the said index.

The rate of interest of such mortgages can be changed as often as every month. The ARM is also known as 'variable rate mortgage' or 'floating rate mortgage'.

**What is an Index?**According to the ARM definition, the interest rate that is paid along with every installment of mortgage, is based upon some or the other economic index. In United States of America, there are six primary indexes that are used by the lenders, in order to set the rate of interest on a particular ARM.

- 11th District Cost of Funds Index
- London Interbank Offered Rate
- 12-month Treasury Average Index
- Bank Bill Swap Rate
- Constant Maturity Treasury
- National Average Contract Mortgage Rate

- In some cases, the
*direct application of index*rate, is used. In such a scenario, the exact percentage change in the index is used to modify the rate of interest. For example, if a rise of 3% is observed in the projection of the index, then the rate in interest will also rise by 3%. - In some cases that
*current index rate plus a margin*, is levied on the installment. The additional margin is specified in the promissory note, and remains constant throughout the time period of the loan. - The third way of levying the rate of interest is with the help of the
*movement of the index*. In this case, the original rate of interest basically keeps on fluctuating and the margin is kept constant.

**How is the Interest on ARM Calculated?**The adjustable mortgage rates, thus basically depends on the type of index that is being followed, and the amount that is payable to the lender. Here's a small illustration that shall prove to be explanatory...

P = The total amount of your mortgageN = Number of Years of the mortgage R = Rate of Interest that is levied initially Therefore according to the formula of simple interest, Interest payable for initial period = PNR/100 The P is split into different installments say 48 installments with 12 per year. In the first year, the rate of interest that is applicable is constant. However in the next 3 years it will fluctuate. Therefore, in such a situation the calculation will go as follows... P _{1} = P minus principal amount already repaid (does not include the interest that has been paid)R _{1} = Rate of interest change according to new index.N = Number of remaining years Therefore according to the formula of simple interest, Interest payable for initial period = P _{1}NR_{1}/100 |

In case if you are wondering which mortgage to choose, you may consult the guidelines that are issued by government agencies, Federal Reserve Board and Federal Home Loan Bank Board. These agencies have also prepared a mortgage checklist for the buyers and borrowers of mortgage loans, so as to help them to understand the concepts and basics of ARM.