Fixed and Adjustable Rates
A fixed rate mortgage (FRM) is a mortgage loan where the interest rate on the note remains the same through the term of the loan, as opposed to loans where the interest rate may adjust or “float”. Other forms of mortgage loans include interest only mortgage, graduated payment mortgage, variable rate (including adjustable rate mortgages and tracker mortgages) , negative amortization mortgage, and balloon payment mortgages. Please note that each of the loan types above except for a straight adjustable rate mortgage can have a period of the loan for which a fixed rate may apply. A Balloon Payment mortgage, for example, can have a fixed rate for the term of the loan followed by the ending balloon payment. Terminology may differ from country to country: loans for which the rate is fixed for less than the life of the loan may be called hybrid adjustable rate mortgages (in the United States).
This payment amount is independent of the additional costs on a home sometimes handled in escrow, such as property taxes and property insurance. Consequently, payments made by the borrower may change over time with the changing escrow amount, but the payments handling the principal and interest on the loan will remain the same.
Fixed rate mortgages are characterized by their interest rate (including compounding frequency, amount of loan, and term of the mortgage). With these three values, the calculation of the monthly payment can then be done.
Adjustable Rate Mortgage Loans
An adjustable rate mortgage (ARM) is a mortgage loan where the interest rate on the note is periodically adjusted based on a variety of indices.
Among the most common indices are the rates on 1-year constant-maturity Treasury (CMT) securities, the Cost of Funds Index (COFI), and the London Interbank Offered Rate (LIBOR). A few lenders use their own cost of funds as an index, rather than using other indices. This is done to ensure a steady margin for the lender, whose own cost of funding will usually be related to the index. Consequently, payments made by the borrower may change over time with the changing interest rate (alternatively, the term of the loan may change). This is not to be confused with the graduated payment mortgage, which offers changing payment amounts but a fixed interest rate. Other forms of mortgage loan include the interest only mortgage, the fixed rate mortgage, the negative amortization mortgage, and the balloon payment mortgage. Adjustable rates transfer part of the interest rate risk from the lender to the borrower. They can be used where unpredictable interest rates make fixed rate loans difficult to obtain. The borrower benefits if the interest rate falls and loses out if interest rates rise.
Adjustable rate mortgages are characterized by their index and limitations on charges (caps). In many countries, adjustable rate mortgages are the norm, and in such places, may simply be referred to as mortgages.
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