An adjustable-rate mortgage, better known as an “ARM,” is a home loan with an interest rate that can change periodically. Your monthly payments will go up or down when interest rates fluctuate.
An ARM starts with an introductory fixed interest rate, then adjusts after the initial fixed interest rate period ends. The rate can change based on the index agreed to in terms. Period terms are set up in advance and range between 3-, 5-, 7- and 10-year terms. This differs from a fixed rate in that a fixed-rate mortgage has the same interest rate for the entire term of the loan.
- Generally, lower initial interest rates than a fixed-rate mortgage
- Start with lower up-front payments
- Shorter loan terms, which may be beneficial if you will not be in your home long
- Caps limiting the amount by which rates and payments change, protecting you from potential steep increases
- Rates and payments can rise over the life of the loan
- Long-term budgeting becomes difficult once an adjustable loan moves into the adjustable phase
- Potential prepayment penalties
- ARMs may be challenging to understand
Before taking out an ARM, the Consumer Financial Protection Bureau recommends asking your lender questions about how your ARM adjusts, such as how frequently your interest rate will change and if there’s a limit on how low your interest rate could go. If you’re afraid of increases in your mortgage, it may be better to go with a fixed rate which will give you the same payment and interest rate throughout the term of the loan.