Interest Only ARM
Unlike an amortizing adjustable rate mortgage (ARM) in which monthly payments consist of both principal and interest, an Interest Only ARM requires just the monthly interest payments. Interest Only ARM's usually begin with a fixed interest rate period based on a selected rate index such as the US Treasury Bill or London Inter-Bank Offer Rate (LIBOR).
An Interest Only ARM will have a period where the interest rate is fixed, and then be adjusted at pre-determined intervals thereafter. Since principal is not paid during the interest only period, monthly payments are less than for the comparable amortizing mortgage. Due to this lack of principal payment, interest only ARM's are technically balloon mortgages because a balloon payment exists at the end of the interest only period. As long as a balloon payment is not required, borrower obligations to the lender have been maintained and an option to refinance to an amortizing mortgage at market rate exists for the borrower. If excersized, the new amortizing loan may adjust up or down and will adjust at a fixed interval through the remainder of the loan term.