What Is Appreciation?

Appreciation, in general terms, is an increase in the value of an asset over time. The increase can occur for a number of reasons, including increased demand or weakening supply, or as a result of changes in inflation or interest rates. This is the opposite of depreciation, which is a decrease in value over time.

How Appreciation Works

Appreciation can be used to refer to an increase in any type of asset, such as a stock, bond, currency, or real estate. For example, the term capital appreciation refers to an increase in the value of financial assets such as stocks, which can occur for reasons such as improved financial performance of the company.

Just because the value of an asset appreciates does not necessarily mean its owner realizes the increase. If the owner revalues the asset at its higher price on their financial statements, this represents a realization of the increase.

Another type of appreciation is currency appreciation. The value of a country’s currency can appreciate or depreciate over time in relation to other currencies.

How to Calculate the Appreciation Rate

The appreciation rate is virtually the same as the compound annual growth rate (CAGR). Thus, you take the ending value, divide by the beginning value, then take that result to 1 dividend by the number of holding periods (e.g. years). Finally, you subtract one from the result. 

 However, in order to calculate the appreciation rate that means you need to know the initial value of the investment and the future value. You also need to know how long the asset will appreciate.

For example, Rachel buys a home for $100,000 in 2016. In 2021, the value has increased to $125,000. The home has appreciated by 25% [($125,000 – $100,000) / $100,000] during these five years. The appreciate rate (or CAGR) is 4.6% [($125,000 / $100,000)^(1/5) – 1].

Appreciation vs. Depreciation

Appreciation is also used in accounting when referring to an upward adjustment of the value of an asset held on a company’s accounting books. The most common adjustment on the value of an asset in accounting is usually a downward one, known as depreciation.

Certain assets are given to appreciation, while other assets tend to depreciate over time. As a general rule, assets that have a finite useful life depreciate rather than appreciate.

Depreciation is typically done as the asset loses economic value through use, such as a piece of machinery being used over its useful life. While appreciation of assets in accounting is less frequent, assets such as trademarks may see an upward value revision due to increased brand recognition.

Real estate, stocks, and precious metals represent assets purchased with the expectation that they will be worth more in the future than at the time of purchase. By contrast, automobiles, computers, and physical equipment gradually decline in value as they progress through their useful lives.

Example of Capital Appreciation

An investor purchases a stock for $10 and the stock pays an annual dividend of $1, equating to a dividend yield of 10%. A year later, the stock is trading at $15 per share and the investor has received the dividend of $1.

The investor has a return of $5 from capital appreciation as the price of the stock went from the purchase price or cost basis of $10 to a current market value of $15. In percentage terms, the stock price increase led to a return from capital appreciation of 50%. The dividend income return is $1, equating to a return of 10% in line with the original dividend yield. The return from capital appreciation combined with the return from the dividend leads to a total return on the stock of $6 or 60%.

Example of Currency Appreciation

China’s ascension onto the world stage as a major economic power has corresponded with price swings in the exchange rate for its currency, the yuan. Beginning in 1981, the currency rose steadily against the dollar until 1996, when it plateaued at a value of $1 equaling 8.28 yuan until 2005. The dollar remained relatively strong during this period. It meant cheaper manufacturing costs and labor for American companies, who migrated to the country in droves.

It also meant that American goods were competitive on the world stage as well as the U.S. due to their cheap labor and manufacturing costs. In 2005, however, China’s yuan reversed course and appreciated 33% in value against the dollar. As of May 2021, it’s still near that retraced level, trading at 6.4 yuan.

Appreciation FAQs

What Is an Appreciating Asset?

An appreciating asset is any asset which value is increasing. For example, appreciating assets can be real estate, stocks, bonds, and currency.

What Is Appreciation Rate?

Appreciation rate is another word for growth rate. The appreciation rate is the rate at which an asset’s value grows.

What Is a Good Home Appreciation Rate?

A good appreciation rate is relative to the asset and risk involved. What might be a good appreciation rate for real estate is different than what is a good appreciation rate for a certain currency given the risk involved.

What Is Meant by Capital Appreciation?

Capital appreciation is the increase in the value or price of an asset. This can include stocks, real estate, or the like.  

The Bottom Line

Appreciation is the rise in the value of an asset, such as currency or real estate. It’s the opposite of depreciation, which reduces the value of an asset over its useful life. Increases in value can be attributed to interest rate changes, supply and demand changes, or various other reasons. 

What Is an Adjustable-Rate Mortgage (ARM)?

The term adjustable-rate mortgage (ARM) refers to a home loan with a variable interest rate. With an ARM, the initial interest rate is fixed for a period of time. After that, the interest rate applied on the outstanding balance resets periodically, at yearly or even monthly intervals.

ARMs are also called variable-rate mortgages or floating mortgages. The interest rate for ARMs is reset based on a benchmark or index, plus an additional spread called an ARM margin. The typical index that is used in ARMs has been the London Interbank Offered Rate (LIBOR).

Understanding Adjustable-Rate Mortgages (ARMs)

Mortgages allow homeowners to finance the purchase of a home or other piece of property. When you get a mortgage, you’ll need to repay the borrowed sum over a set number of years as well as pay the lender something extra to compensate them for their troubles and the likelihood that inflation will erode the value of the balance by the time the funds are reimbursed.

In most cases, you can choose the type of mortgage loan that best suits your needs. A fixed-rate mortgage comes with a fixed interest rate for the entirety of the loan. As such, your payments remain the same. An ARM, where the rate fluctuates based on market conditions. This means that you benefit from falling rates and also run the risk if rates increase.

There are two different periods to an ARM. One is the fixed period and the other is the adjusted period. Here’s how the two differ:

• Fixed Period: The interest rate doesn’t change during this period. It can range anywhere between the first five, seven, or 10 years of the loan. This is commonly known as the intro or teaser rate.
• Adjusted Period: This is the point at which the rate changes. Changes are made during this period based on the underlying benchmark, which fluctuates based on market conditions.

Another key characteristic of ARMs is whether they are conforming or nonconforming loans. Conforming loans are those that meet the standards of government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. They are packaged and sold off on the secondary market to investors. Nonconforming loans, on the other hand, aren’t up to the standards of these entities and aren’t sold as investments.

Rates are capped on ARMs. This means that there are limits on the highest possible rate a borrower must pay. Keep in mind, though, that your credit score plays an important role in determining how much you’ll pay. So, the better your score, the lower your rate.

Types of ARMs

ARMs generally come in three forms: Hybrid, interest-only (IO), and payment option. Here’s a quick breakdown of each.

Hybrid ARM

Hybrid ARMs offer a mix of a fixed- and adjustable-rate period. With this type of loan, the interest rate will be fixed at the beginning and then begin to float at a predetermined time.

This information is typically expressed in two numbers. In most cases, the first number indicates the length of time that the fixed rate is applied to the loan, while the second refers to the duration or adjustment frequency of the variable rate.

For example, a 2/28 ARM features a fixed rate for two years followed by a floating rate for the remaining 28 years. In comparison, a 5/1 ARM has a fixed rate for the first five years, followed by a variable rate that adjusts every year (as indicated by the number one after the slash). Likewise, a 5/5 ARM would start with a fixed rate for five years and then adjust every five years.

Interest-Only (I-O) ARM

It’s also possible to secure an interest-only (I-O) ARM, which essentially would mean only paying interest on the mortgage for a specific time frame—typically three to 10 years. Once this period expires, you are then required to pay both interest and the principal on the loan.

These types of plans appeal to those keen to spend less on their mortgage in the first few years so that they can free up funds for something else, such as purchasing furniture for their new home. Of course, this advantage comes at a cost: The longer the I-O period, the higher your payments will be when it ends.

Payment-Option ARM

A payment-option ARM is, as the name implies, an ARM with several payment options. These options typically include payments covering principal and interest, paying down just the interest, or paying a minimum amount that does not even cover the interest.

Opting to pay the minimum amount or just the interest might sound appealing. However, it’s worth remembering that you will have to pay the lender back everything by the date specified in the contract and that interest charges are higher when the principal isn’t getting paid off. If you persist with paying off little, then you’ll find your debt keeps growing—perhaps to unmanageable levels.

Advantages and Disadvantages of ARMs

Adjustable-rate mortgages come with many benefits and drawbacks. We’ve listed some of the most common ones below.

Advantages

The most obvious advantage is that a low rate, especially the intro or teaser rate, will save you money. Not only will your monthly payment be lower than most traditional fixed-rate mortgages, you may also be able to put more down toward your principal balance. Just ensure your lender doesn’t charge you a prepayment fee if you do.

ARMs are great for people who want to finance a short-term purchase, such as a starter home. Or you may want to borrow using an ARM to finance the purchase of a home that you intend to flip. This allows you to pay lower monthly payments until you decide to sell again.

More money in your pocket with an ARM also means you have more in your pocket to put toward savings or other goals, such as a vacation or a new car.

Unlike fixed-rate borrowers, you won’t have to make a trip to the bank or your lender to refinance when interest rates drop. That’s because you’re probably already getting the best deal available.

Disadvantages

One of the major cons of ARMs is that the interest rate will change. This means that if market conditions lead to a rate hike, you’ll end up spending more on your monthly mortgage payment. And that can put a dent in your monthly budget.

ARMs may offer you flexibility but they don’t provide you with any predictability as fixed-rate loans do. Borrowers with fixed-rate loans know what their payments will be throughout the life of the loan because the interest rate never changes. But because the rate changes with ARMs, you’ll have to keep juggling your budget with every rate change.

These mortgages can often be very complicated to understand, even for the most seasoned borrower. There are various features that come with these loans that you should be aware of before you sign your mortgage contracts, such as caps, indexes, and margins.

How the Variable Rate on ARMs Is Determined

At the end of the initial fixed-rate period, ARM interest rates will become variable (adjustable) and will fluctuate based on some reference interest rate (the ARM index) plus a set amount of interest above that index rate (the ARM margin). The ARM index is often a benchmark rate such as the prime rate, the LIBOR, the Secured Overnight Financing Rate (SOFR), or the rate on short-term U.S. Treasuries.

Although the index rate can change, the margin stays the same. For example, if the index is 5% and the margin is 2%, the interest rate on the mortgage adjusts to 7%. However, if the index is at only 2% the next time that the interest rate adjusts, the rate falls to 4% based on the loan’s 2% margin.

Adjustable-Rate Mortgage vs. Fixed Interest Mortgage

Unlike ARMs, traditional or fixed-rate mortgages carry the same interest rate for the life of the loan, which might be 10, 20, 30, or more years. They generally have higher interest rates at the outset than ARMs, which can make ARMs more attractive and affordable, at least in the short term. However, fixed-rate loans provide the assurance that the borrower’s rate will never shoot up to a point where loan payments may become unmanageable.

With a fixed-rate mortgage, monthly payments remain the same, although the amounts that go to pay interest or principal will change over time, according to the loan’s amortization schedule.

If interest rates in general fall, then homeowners with fixed-rate mortgages can refinance, paying off their old loan with one at a new, lower rate.

Is an ARM Right for You?

An ARM can be a smart financial choice if you are planning to keep the loan for a limited period of time and will be able to handle any rate increases in the meantime. Put simply, an adjustable-rate mortgage is well suited for the following types of borrowers:

• People who intend to hold the loan for a short period of time
• Individuals who expect to see a positive change in their income
• Anyone who can and will pay off the mortgage within a short time frame

In many cases, ARMs come with rate caps that limit how much the rate can rise at any given time or in total. Periodic rate caps limit how much the interest rate can change from one year to the next, while lifetime rate caps set limits on how much the interest rate can increase over the life of the loan.

Notably, some ARMs have payment caps that limit how much the monthly mortgage payment can increase, in dollar terms. That can lead to a problem called negative amortization if your monthly payments aren’t sufficient to cover the interest rate that your lender is changing. With negative amortization, the amount that you owe can continue to increase, even as you make the required monthly payments.

The Bottom Line

Borrowers have many options available to them when they want to finance the purchase of their home or another type of property. You can choose between a fixed-rate or adjustable-rate mortgage. While the former provides you with some predictability, ARMs offer lower interest rates for a certain period of time before they begin to fluctuate with market conditions. There are different types of ARMs to choose from and they have pros and cons. But keep in mind that these kinds of loans are better suited for certain kinds of borrowers, including those who intend to hold onto a property for the short term or if they intend to pay off the loan before the adjusted period begins. If you’re unsure, talk to a financial expert about your options.

Who Is Alan Greenspan?

Alan Greenspan is an American economist who was the chair of the Board of Governors of the Federal Reserve (Fed), the United States’ central bank, from 1987 until 2006. In that role, he also served as the chair of the Federal Open Market Committee (FOMC), which is the Fed’s principal monetary policymaking committee that makes decisions on interest rates and managing the U.S. money supply.

Greenspan is best known for largely presiding over the Great Moderation, a period of relatively stable inflation and macroeconomic growth, that lasted from the mid-1980s to the financial crisis in 2007.

Early Life and Education

Alan Greenspan was born in New York City on March 6, 1926. He received his bachelor’s, master’s, and doctoral degrees in economics, all from New York University, as well as studying economics at Columbia University in the early 1950s under Arthur Burns, who would later serve two consecutive terms as chair of the Board of Governors of the Fed.

Greenspan’s first job, in 1948, was not in government but for a non-profit analyzing demand for steel, aluminum, and copper. After this, Greenspan ran an economic consulting firm in New York City, Townsend-Greenspan & Co., Inc., from 1954 to 1974 and 1977 to 1987. Greenspan began his career in the public sector in 1974 when he served as chair of the President’s Council of Economic Advisers (CEA) under President Gerald Ford.

In 1987, Greenspan became the 13th chair of the Fed, replacing Paul Volcker. President Ronald Reagan was the first to appoint Greenspan to the office, but three other presidents, George H.W. Bush, Bill Clinton, and George W. Bush, named him to four additional terms. His tenure as chair lasted for more than 18 years before he retired in 2006 to be replaced by Ben Bernanke. After leaving, he published his memoir, The Age of Turbulence, and began his own Washington DC-based consulting firm, Greenspan Associates LLC. 

Alan Greenspan was known as being adept at gaining consensus among Fed board members on policy issues and for serving during one of the most severe economic crises of the late 20th century, the aftermath of the stock market crash of 1987. After that crash, he advocated for sharply slashing interest rates to prevent the economy from sinking into a deep depression.

Alan Greenspan’s Policies and Actions

Greenspan presided over one of the most prosperous periods in American history—thanks in no small part, supporters feel, to his helming of the Fed. Still, some of his policies and actions were controversial, either at the time or in retrospect.

Views on Inflation

Early in his career, Greenspan developed a reputation for being hawkish on inflation, in part due to his advocacy for a return to the gold standard in monetary policy in the 1967 essay “Gold and Economic Freedom.” 

His allegedly “hawkish” stance was portrayed by early critics as a preference for sacrificing economic growth in exchange for preventing inflation. Greenspan eventually reversed those views as Fed chief; in a 1998 speech, he conceded that the new economy might not be as susceptible to inflation as he had first thought.

In practice, Greenspan’s supposedly hawkish approach was flexible, to say the least. He was clearly willing to risk inflation under conditions that could create a severe depression and certainly pursued a generally easy money policy relative to his predecessor, Paul Volcker. In particular, in the early 2000s, Greenspan presided over cutting interest rates to levels not seen in many decades.

Flip-Flop on Interest Rates

In 2000, Greenspan advocated reducing interest rates after the dot-com bubble burst. He did so again in 2001 after 9-11, the World Trade Center attack. Following 9-11, Greenspan led the FOMC to immediately reduce the Fed funds rate from 3.5% to 3%, and, in the following months, he worked toward lowering that rate to a record (at the time) low of 1.13% and holding it there for a full year.

Some criticized those rate cuts as having the potential to inflate asset price bubbles in the U.S. Greenspan’s pro-inflationary policies, particularly during this period, are today generally understood to have contributed to the U.S. housing bubble, subsequent subprime mortgage financial crisis, and the Great Recession, though this is of course disputed by Greenspan and his allies.

Encouraging Adjustable-Rate Mortgages

In a 2004 speech, Greenspan suggested more homeowners should consider taking out adjustable-rate mortgages (ARMs) where the interest rate adjusts itself to prevailing market interest rates. Under Greenspan’s tenure, interest rates subsequently rose as inflation accelerated. This increase reset many of those mortgages to much higher payments, creating even more distress for many homeowners and exacerbating the impact of that crisis.

The “Greenspan Put”

The “Greenspan put” was a monetary policy strategy popular during the 1990s and 2000s under Greenspan. Throughout his reign, he attempted to help support the U.S. economy by actively using the federal funds rate to aggressively lower interest rates to fight the deflation of asset price bubbles.

The Greenspan put created a substantial moral hazard in financial markets. Informed investors could expect the Fed to take predictable actions that would bailout investor’s losses, which distort the incentives of market participants. This created an environment where investors were encouraged to take excessive risk because Fed monetary policy tended to inherently limit their potential losses in the event of a market downturn in an analogous way to buying put options on the open market.

The Bottom Line

Like many other government officials, the success of Alan Greenspan’s five terms as Chair of the Fed will depend on who you ask. However, it is certainly true that Greenspan faced some massive challenges during his tenure, such as the 1987 stock market crash and the attacks on the World Trade Center.

Overall, Greenspan helped usher in a strong U.S. economy in the 1990s. Opinion on how much his actions caused the economic recession that began shortly after his term ended varies.