Adjustable rate mortgages (ARM) are confusing to many people.

Here is my attempt at a simple explanation-

An ARM is a combination of an index and margin. Margin= The profit a bank charges. Aka "profit margin". This does not change.

The loan is tied to an index (see below). Indexes vary on many factors. All you need to know is that they change. When you add the index + margin = rate.

To avoid payment shock many ARM products have Caps. Meaning no matter how high an index may go it is capped at a certain level per year and for the life of the loan.

Example a 1% cap means the rate cannot increase more than 1% regardless of how high the index may increase.

ARM products are productive when used properly. Used in the wrong situation and they can cause financial hardship.

One-year constant maturity Treasury (CMT)
securities

The weekly average yield on U.S. Treasury
securities adjusted to a constant maturity of one
year as made available by the Federal Reserve
Board

Three-year constant maturity Treasury (CMT)
securities

The weekly average yield on U.S. Treasury
securities adjusted to a constant maturity of
three years as made available by the Federal
Reserve Board

Ten-year constant maturity Treasury (CMT)
securities

The weekly average yield on U.S. Treasury
securities adjusted to a constant maturity of
ten years, as made available by the Federal
Reserve Board.

London Interbank Offered Rate (LIBOR)

The average rate for U.S. dollar-denominated
deposits in the London market based on
quotations of major banks.

"Cost of funds" (COFI)

The monthly weighted-average cost of savings,
borrowings, and advances of the 11th District
members of the Federal Home Loan Bank of
San Francisco.

Certificate of deposit

The weekly average of secondary market
interest rates on 6-month negotiable certificates
of deposit as made available by the Federal
Reserve Board