Adjustable Rate Mortgage
An adjustable rate commercial mortgage is the same as a residential adjustable rate mortgage (ARM). This type of loan is where the interest rate adjusts periodically up or down through a set index. This can also be referred to as a floating rate mortgage. The rate is fixed for a period at the beginning, called the “initial rate period”, but after that it may change based on movements in an interest rate index. ARMs are contrasted with fixed-rate mortgages (FRMs) on which the quoted rate holds for the entire life of the mortgage.
The adjustment interval is the period of time between changes in the interest rate for an adjustable-rate mortgage. Typical adjustment intervals are one year, three, and five years.
The indices used are typically the one-year Constant-Maturity Treasury (CMT), the Cost of Funds Index (COFI), or the London Interbank Offered Rate (LIBOR). The interest rate on the floating rate loan is determined by adding a few percentage points, called a margin to the index rate. For example, suppose that the one-month LIBOR rate is currently at 3.00%. The lender determines that ARMs for a certain risk set should be given a margin of 50 basis points (or 0.50%) above the index. The ARM interest rate for that period would then be 3.50%.