What Is an Adjustable-Rate Mortgage (ARM)?

An adjustable-rate mortgage (ARM) is a home loan with an interest rate that stays fixed for an initial period, then adjusts at scheduled intervals. Once adjustments begin, your rate—and monthly principal-and-interest payment—could increase or decrease.

An ARM can be worth considering, but homebuyers should understand both the starting payment and how that payment could change.

How does an adjustable-rate mortgage work?

An ARM has two main phases:

• Fixed-rate period: Your interest rate stays the same for a set number of years.
• Adjustable-rate period: Your interest rate can change on a schedule outlined in your loan documents.

For example, a 5/6 ARM generally has a fixed interest rate for the first five years, then adjusts every six months. The first number describes the initial fixed period in years; the second describes the adjustment frequency in months. Always confirm the terms of the specific loan.

What determines your rate after it adjusts?

After the fixed period, your rate is generally calculated using:

• Index: A benchmark interest rate that changes with market conditions.
• Margin: A set percentage added to the index, as specified in your loan agreement.
• Rate caps: Limits on how much your rate can change at the first adjustment, at later adjustments, and over the life of the loan.

Rate caps limit changes, but they do not guarantee an affordable payment. Ask your lender to explain the highest rate and payment your loan could allow.

What are the benefits of an ARM?

An ARM may offer a lower starting interest rate than a comparable fixed-rate mortgage, though that is not guaranteed. A lower initial rate could mean a smaller principal-and-interest payment during the fixed period.

That may appeal to buyers who expect to own the home for a shorter time. Still, the decision should account for what happens if you stay longer than planned.

What are the risks?

The biggest risk is a higher payment after the fixed period ends. If rates rise, your payment could increase enough to affect your household budget.

Selling or refinancing may be options, but neither is guaranteed. Your income, credit, home value, and available loan terms could change. Also, property taxes and homeowners insurance can increase your total monthly housing payment—even while your ARM’s interest rate is fixed.

Is an ARM better than a fixed-rate mortgage?

Neither option is automatically better.

A fixed-rate mortgage offers a consistent interest rate and predictable principal-and-interest payments throughout the loan. An ARM trades some long-term payment certainty for the possibility of a lower starting rate.

An ARM may be worth considering if you understand the adjustment terms and could comfortably handle higher payments if your plans change.

What should homebuyers ask before choosing an ARM?

Ask your lender:

• How long does the initial interest rate last?
• How often can the rate adjust afterward?
• What index, margin, and rate caps apply?
• What is the highest possible payment, and when could it occur?
• How do the initial rate, annual percentage rate (APR), fees, and payments compare with a fixed-rate loan?

APR reflects interest and certain loan costs, but an ARM’s disclosed APR does not predict future rate changes.

Bottom line: Don’t choose an ARM based only on the starting payment. Choose it only after you understand the adjustment terms and know your budget can handle the risk.

Loan programs, rates, terms, and eligibility are subject to applicable guidelines and approval. This content is for educational purposes only and is not a commitment to lend.