What defines an adjustable-rate mortgage (ARM)?

• A. A mortgage with a fixed interest rate for the entire term
• B. A mortgage where the interest rate may change periodically
• C. A loan that requires a large initial payment
• D. A loan that allows for pre-payment without penalties

Answer: (B)

An adjustable-rate mortgage (ARM) is characterized by an interest rate that may change periodically, typically in relation to an index that reflects the cost to the lender of borrowing on the credit markets. This change can lead to varying monthly payments over the life of the loan, differentiating it from fixed-rate mortgages that maintain the same interest rate throughout the loan term. Borrowers often opt for ARMs when seeking lower initial rates compared to fixed-rate options, with awareness that rates can rise or fall in the future based on the terms set in the loan agreement. This flexibility in interest rates is the essential feature that defines an ARM.