Legal Definitions - flexible-rate mortgage

A flexible-rate mortgage, also commonly known as an adjustable-rate mortgage (ARM), is a type of home loan where the interest rate is not fixed for the entire duration of the loan. Instead, the interest rate can change periodically based on a specific financial index, such as the prime rate or a Treasury bill rate. This means that the borrower's monthly mortgage payments can increase or decrease over time, reflecting changes in the broader market interest rates. Flexible-rate mortgages often start with a lower interest rate than fixed-rate mortgages, which can be attractive to borrowers, but they also carry the risk of higher payments if interest rates rise.

• Example 1 (Rising Rates): Sarah and Tom purchase their first home using a flexible-rate mortgage that offers a very low interest rate for the first three years. After this initial period, the interest rate adjusts annually. In the fourth year, due to a general increase in market interest rates, their mortgage rate rises, causing their monthly payment to increase by $200.

  Explanation: This illustrates a flexible-rate mortgage because the interest rate on their loan, and consequently their monthly payment, changed after the initial fixed period, directly reflecting the movement of market rates.

• Example 2 (Falling Rates): David took out a flexible-rate mortgage five years ago. For the first few years, his payments were stable. However, in the current economic climate, the central bank has significantly lowered interest rates to stimulate the economy. As a result, when his mortgage rate adjusts this year, it drops by a full percentage point, leading to a noticeable reduction in his monthly mortgage payment.

  Explanation: This example demonstrates how a flexible-rate mortgage can also benefit a borrower. The interest rate on David's loan adjusted downwards in response to falling market rates, resulting in lower payments, which is a key characteristic of this type of mortgage.

• Example 3 (Strategic Use): Maria plans to live in her current city for only about five to seven more years before relocating for a new job opportunity. To take advantage of lower initial payments, she chooses a flexible-rate mortgage with a fixed rate for the first five years, after which it will adjust annually. She anticipates selling her home before the rate has a chance to significantly increase, making the initial savings more appealing than the long-term stability of a fixed-rate loan.

  Explanation: Maria's choice highlights the strategic use of a flexible-rate mortgage. She is leveraging the typically lower initial interest rate, knowing that her financial commitment to the property is relatively short-term, thereby minimizing her exposure to potential future rate increases. The loan's structure, with its initial fixed period followed by adjustments, defines it as a flexible-rate mortgage.