The interest rate which keeps changing periodically is referred to as adjustable rate. The fluctuation or change is generally connected to the movements of an external indicator, like the prime rate of interest. The movement below or above certain levels is usually avoided by a floor or ceiling which is predetermined for a particular rate. Thus you may see a “prime plus 2%” rate, which means that the loan rate always will be 2% more than the prime rate. This will fluctuate regularly for taking into consideration inflationary changes in the rate.
An individual who takes a fixed rate loan during low rates is allowed to “lock in” the low rates of interest without bothering about fluctuations. On the contrary, if the interest rates were abnormally high when taking a loan, the individual will be benefited from a floating rate of interest loan. This is because when the prime interest rate would fall to normal levels, the loan rate would decrease.
What is adjustable rate mortgage (ARM)?
Adjustable rate mortgage is a term used in mortgage loan. It refers to a rate of interest which may fluctuate as a result of Treasury bill rate or the prime rate. Adjustable rate mortgage generally begins with better rates as compared to fixed rate mortgages with a view to compensating the borrower for the extra risk on account of future fluctuations of interest rate.
Some of the common forms of adjustable rate mortgages are:
• 10/1 ARM – This is fixed for 10 years or 120 months, and annually adjusts for the rest of the loan term.
• 7/1 ARM – This form of ARM is fixed for 7 years or 84 months and annually adjusts for the rest of loan term.
• 5/1 ARM – This is a form of ARM which is fixed for 5 years or 60 months and which adjusts annually for the rest of the loan term.
• 3/1 ARM – This is for a fixed period of 3 years or 36 months that adjusts annually for the rest of period of the loan.
The above calculations are done on a wholly amortizing ARM which is known to be the commonest forms of ARMs. The calculation of the monthly payment is done in order to payoff the entire mortgage loan balance at the end of a term, which is typically 30 years. After the passing of a period of fixed interest rate, the rate of interest as well as the payment adjusts at the specified frequency. A fully amortizing ARM has a ceiling/maximum rate which it does not exceed.
What is adjustable rate preferred stock (ARPS)?
This is a form of preferred stock where the dividends are variable according to a set benchmark – in most cases a Treasury bill rate. The preferred share’s dividend value is fixed through a predetermined formula for moving according to the rates. On account of this flexibility associated with it, the preferred prices are frequently more stable as compared to fixed – rate preferred stocks.
These are the two primary areas where the “adjustable rate” is applicable.