ARM Margin

What is 'ARM Margin'

An ARM margin is a fixed percentage rate that is added to an indexed rate to determine the fully indexed interest rate of an adjustable rate mortgage (ARM). Adjustable rate mortgages are one of the most common variable rate credit products offered in the primary lending market.

BREAKING DOWN 'ARM Margin'

An ARM margin is a very important and often overlooked part of the adjustable rate mortgage loan's interest rate. The ARM margin typically encompasses the majority of interest a borrower pays on their loan. It is added to the product’s specified index rate to determine the fully indexed interest rate that the borrower pays on the loan. Terms for the indexed rate and ARM margin are detailed in the loans credit agreement.

Adjustable rate mortgage loans are a popular home mortgage product. They are structured with an amortization schedule that provides the lender steady cash flow through installment payments. When rates are rising the adjustable rate on an ARM increases which benefits the lender and generates a greater level of interest income. Adjustable rate mortgage loans are beneficial for borrowers when rates are falling.

With an adjustable rate mortgage the borrower pays both fixed and variable rate interest over the life of the loan. The first few years of the loan require a fixed interest rate while the remaining years have a variable rate. Borrowers can identify the fixed and variable years by the product’s quote. For example a 5/1 ARM would have a fixed rate for five years and a variable rate after that which resets every year.

Indexed Rates

The indexed rate on an adjustable rate mortgage is what causes the fully indexed rate to fluctuate for the borrower. In variable rate products, such as an ARM, the lender chooses a specific benchmark for which to index the base interest rate to. Indexes can include LIBOR, the lender’s prime rate and various different types of U.S. Treasuries. A variable rate product’s indexed rate will be disclosed in the credit agreement. Any changes to the indexed rate will cause a change for the borrower’s fully indexed interest rate.

ARM Margin Levels

The ARM margin is the second component involved in a borrower’s fully indexed rate on an adjustable rate mortgage. In an ARM the underwriter determines an ARM margin level which is added to the indexed rate to create the fully indexed interest rate that the borrower is expected to pay. High credit quality borrowers can expect to have a lower ARM margin which results in a lower interest rate overall on the loan. Lower credit quality borrowers will have a higher ARM margin which requires them to pay higher rates of interest on their loan.