An adjustable-rate mortgage or ARM is a mortgage that has an interest rate that changes over time. Typically, the rate is tied to a publicly available rate such as the London Interbank Offered Rate (LIBOR).
To encourage borrowers to sign a loan application, some ARMs can and do use teaser interest rates as a come-on. This is an interest rate that initially is well below market interest rates. However, the rate expires after a specified period, and the rate resets to the one calculated as specified in the contract.
Teaser rates can be loss leaders. Many have been attracted to mortgages they cannot afford once the ARM resets. Previously they could refinance at a lower interest rate using the equity accumulated in their property while housing prices were rising quickly. But declines in housing values have caused many to lose what little equity they had and sometimes to lose their homes in foreclosure.
Those who borrow with ARMs should be careful to fully understand the formula used to calculate the interest rate and the monthly payments required once the teaser rater rate expires.
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