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What is an adjustable rate mortgage (ARM)?

In commercial real estate, an adjustable rate mortgage (ARM) is a type of loan where the interest rate can change over time based on market conditions. With an ARM, the interest rate is typically fixed for an initial period of time, such as 5, 7, or 10 years, and then can adjust up or down on a regular basis, such as annually or every 6 months.

The interest rate on an ARM is tied to a benchmark index, such as the London Interbank Offered Rate (LIBOR) or the Constant Maturity Treasury (CMT) rate, plus a margin. The margin is a fixed percentage that is added to the benchmark index to determine the borrower’s interest rate.

The advantage of an ARM is that it often offers a lower initial interest rate than a fixed-rate loan, which can make it more affordable for borrowers. This can be particularly attractive for borrowers who plan to sell or refinance the property within a few years.

However, the disadvantage of an ARM is that the interest rate can rise significantly over time, potentially leading to higher monthly payments and a higher overall cost of borrowing. This can be particularly risky for borrowers who plan to hold the property for the long term.

Overall, an ARM can be a good choice for borrowers who are looking for lower initial payments and who plan to sell or refinance the property within a few years. However, borrowers should carefully consider the risks associated with an ARM and ensure that they can afford higher payments in the future if the interest rate rises.

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