Nationwide Mortgage Licensing System (NMLS) Practice Exam

Which of the following best describes an adjustable-rate mortgage (ARM)?

1. A mortgage with a fixed rate for its entire term

2. A mortgage whose interest rate changes periodically

3. A mortgage that has no interest charged

4. A mortgage that can only be refinanced

The correct answer is: A mortgage whose interest rate changes periodically

An adjustable-rate mortgage (ARM) is characterized by an interest rate that changes periodically, typically in relation to an index or benchmark interest rate. This means that rather than having a fixed interest rate for the entire life of the loan, the interest rate can fluctuate at predetermined intervals—such as annually or every few years. This periodic adjustment can lead to lower initial payments compared to fixed-rate mortgages, which makes ARMs appealing to some borrowers who anticipate changes in their financial situations or interest rates in the future. The descriptions in the other options do not accurately reflect the nature of an ARM. A fixed-rate mortgage, for example, maintains the same interest rate throughout its entire term, which is contrary to the adjustable nature of an ARM. A mortgage with no interest charged does not exist in standard lending practices, as all mortgages involve the payment of interest over time as part of the cost of borrowing. Lastly, while refinancing may be a part of mortgage planning, an ARM can still be active without needing to be refinanced; it does not define the mortgage type itself. Thus, the defining feature of an ARM is its variable interest rate, which makes the second option the most accurate description.