The Federal Reserve put out a helpful little consumer guide this week, and you don’t have to know anything about industrial production and capacity utilization to understand it. The new handbook explains adjustable-rate mortgages (or ARMs), along with some of the pitfalls associated with these increasingly popular and increasingly complicated loan arrangements.

In its simplest form, an ARM is a mortgage with an interest rate that adjusts periodically. The initial rate is typically lower than a fixed-rate mortgage. That makes them attractive to many buyers. People who know they will not live in their new home very long, in particular, can get a significant financial advantage from choosing an adjustable-rate mortgage. The Federal Reserve, however, has been concerned that promises of low payments may be luring some consumers into mortgages that don’t make financial sense. Among those potentially questionable loans are interest-only mortgages, which require the borrower to pay only the loan interest during the first few years. That means the homeowner builds no equity, even though the early payments might be smaller. (more…)

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