Interest-Only ARM

AAA

DEFINITION of 'Interest-Only ARM'

An adjustable-rate mortgage (ARM) with an initial interest-only payment period. During the interest-only period, only the calculated interest must be paid; no principal must be repaid. The length of the interest-only period varies with each mortgage type. After the interest-only period, the mortgage must amortize so that the mortgage will be paid off by the end of its original term. This means that monthly payments must increase substantially after the initial interest-only period lapses.

INVESTOPEDIA EXPLAINS 'Interest-Only ARM'

Interest-only ARMs carry a great deal of payment-shock risk. Not only do the payments have the potential to increase because of an increasing fully indexed interest rate, but the expiration of the interest-only payment means that payments will increase when it becomes a fully amortizing payment. Additionally, because the mortgage's principal balance is not reduced during the interest-only period, the rate at which home equity increases, or decreases, is entirely dependent upon home-price appreciation. Most borrowers intend to refinance an interest-only ARM before the interest-only period ends, however a reduction in home equity can make this difficult.

RELATED TERMS
  1. Payment Option ARM

    A monthly adjusting adjustable-rate mortgage (ARM) which allows ...
  2. Mortgage Life Insurance

    An insurance policy designed specifically to repay mortgage debt ...
  3. Fixed-Period ARM

    An adjustable-rate mortgage (ARM) with an initial fixed-interest-rate ...
  4. Payment Shock

    The risk that a loan's scheduled future periodic payments may ...
  5. Hybrid ARM

    A hybrid adjustable-rate mortgage blends the characteristics ...
  6. Adjustable-Rate Mortgage - ARM

    A type of mortgage in which the interest rate paid on the outstanding ...
RELATED FAQS
  1. Do mortgage escrow accounts earn interest?

    A bank is not required to pay interest on any escrow accounts (also mortgage impound accounts) it holds for its customers. ... Read Full Answer >>
  2. What role did securitization play in the U.S. subprime mortgage crisis?

    The securitization of subprime mortgages into mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) ... Read Full Answer >>
  3. How often is interest compounded?

    Interest can be compounded on any given frequency schedule. Common interest compounding time frames are daily, monthly, semi-annually ... Read Full Answer >>
  4. How does the loan-to-value ratio affect my mortgage payments?

    Several factors affect the mortgage rate you can obtain when you purchase a home. Lenders analyze credit histories and scores ... Read Full Answer >>
  5. What's the difference between a collateralized debt obligation (CDO) and a collateralized ...

    A collateralized mortgage obligation, or CMO, is a type of mortgage-backed security (MBS) issued by an lender that handles ... Read Full Answer >>
  6. What is the difference between a savings & loan company and a bank?

    Savings and loan (S&L) companies provide many of the same services to customers as banks, including deposits, loans, ... Read Full Answer >>
Related Articles
  1. Insurance

    ARMed And Dangerous

    In a climate of rising interest rates, having an adjustable-rate mortgage can be risky.
  2. Home & Auto

    Choose Your Monthly Mortgage Payments

    Exotic mortgages allow you to decide how much to pay. Find out how much they really cost.
  3. Credit & Loans

    Mortgages: Fixed-Rate Versus Adjustable-Rate

    Both of these have advantages and disadvantages depending on your financial needs and prospects.
  4. Home & Auto

    5 Risky Mortgage Types To Avoid

    There are plenty of ways to end up with a bad mortgage. The risks of these five should make every homebuyer think twice before signing.
  5. Credit & Loans

    Interest-Only Mortgages: Home Free Or Homeless?

    These loans can be beneficial, but for many borrowers, they present a financial trap.
  6. Home & Auto

    Option ARMs: American Dream Or Mortgage Nightmare?

    Option adjustable rate mortgages could make or break your home-buying experience.
  7. Options & Futures

    This ARM Has Teeth

    Find out how to avoid getting bitten when your mortgage rate resets.
  8. Credit & Loans

    Is A 30-Year Mortgage Really Best?

    It's the most popular choice, but home buyers with 30-year mortgages may be paying more to finance their home than they need to.
  9. Credit & Loans

    What Are The Pros and Cons Of A 15-Year Mortgage?

    The shorter term, and higher monthly payment, are only part of the picture.
  10. Credit & Loans

    Which Is Better: A 30-Year Or 15-Year Mortgage?

    The difference in monthly payments is what homebuyers think of first when they compare the two. But have you considered these other points?

You May Also Like

Hot Definitions
  1. Adverse Selection

    1. The tendency of those in dangerous jobs or high risk lifestyles to get life insurance. 2. A situation where sellers have ...
  2. Wash Trading

    The process of buying shares of a company through one broker while selling shares through a different broker. Wash trading ...
  3. Fixed-Income Arbitrage

    An investment strategy that attempts to profit from arbitrage opportunities in interest rate securities. When using a fixed-income ...
  4. Venture-Capital-Backed IPO

    The selling to the public of shares in a company that has previously been funded primarily by private investors. The alternative ...
  5. Merger Arbitrage

    A hedge fund strategy in which the stocks of two merging companies are simultaneously bought and sold to create a riskless ...
  6. Market Failure

    An economic term that encompasses a situation where, in any given market, the quantity of a product demanded by consumers ...
Trading Center