Discretionary ARM allows the lender has the right to change the interest rate at any point of time. But before exercising the right, the lender ensure to give a certain notice to the borrow about change of interest rate. Discretionary ARM differs structured adjustable-rate mortgage. Before implementing a rate change or amount change, the borrower should be informed well in advance. The short introductory period maybe six weeks before the new interest rate comes into effect.
In Discretionary Adjustable Rate Mortgages (ARM), the lender has contractual right change the interest rate for any reason and any amount. The pitfalls of the discretionary ARM discourages the borrowers as they will be at mercy of the lenders for which the lenders may exercise the right to change the interest or amount at any point of time. Every borrower must ensure that there will be maximum risk in discretionary ARM. However the lenders also disadvantage as the exercise of discretion may result in high default rates. Besides discretion is inconsistent with securitization.
The discretionary ARM mortgage loans available in UK, Australia and India beside other countries who use discretionary ARMs as primary home loan instrument. As the indexed price ARM prevails in the United States, the discretionary ARMs not available in the United States. The discretionary ARM method is popular mortgage in Europe and other developed countries. In United States, the ARMs base rate changed on pre-selected interest rate. The lenders will not have any control over such pre-selected interest rate. It means, the indexed ARMs will not have discretion with rate changes.
The lenders use their discretion to meet their own needs and ignore the needs of borrowers. Besides, the lenders do not want to impose frequent payment changes on borrowers and constantly fix a predetermined higher rate of interest prediction of future needs of lender. Such fixing higher rate avoids systematic adjustment of rate.
The discretionary ARM is opposed to Indexed ARM. The rate adjustments are completely rule based on Indexed ARM, where such changes are discretionary powers of lender in the Discretionary ARM which is another pitfall of such method. The rate changes of ARM are mechanical in the United States. The lenders may not have any control on rate changes in ARM as the changes are based on interest rate index. Indexed ARMs are familiar in United States and these are preferable since no control of lenders over changes of interest rates on ARMs.