Adjustable-Rate Mortgage (ARM)
An adjustable-rate mortgage, or ARM, is a home loan with an interest rate that is typically fixed for an introductory period and may then change at scheduled intervals. The initial rate may be lower than the rate available on a comparable fixed-rate mortgage, but the interest rate and monthly principal-and-interest payment can increase or decrease after the fixed period ends.
Frequently Asked Questions
How does an adjustable-rate mortgage work?
An ARM begins with an initial period during which the interest rate remains fixed. After that period, the rate adjusts according to the loan’s schedule and terms. Future changes are generally based on a market index plus a lender-established margin, subject to the loan’s rate caps.
What do numbers such as 5/1 mean?
With a 5/1 ARM, the initial interest rate is fixed for five years. After the initial period, the rate may adjust once each year. Other ARMs may have different fixed periods and adjustment schedules, so borrowers should review the specific loan terms carefully.
Can my monthly payment increase?
Yes. If the interest rate increases after the introductory period, the monthly principal-and-interest payment will generally increase. Borrowers should consider whether they could comfortably afford the maximum payment permitted under the loan terms.
Can my interest rate or payment decrease?
It may decrease if the applicable market index falls, but not every ARM works the same way. The loan may include limits on how far the rate can decrease, and the margin and other contract terms will continue to apply.
What are the index and margin?
The index is a market-based interest rate that can change over time. The margin is a fixed number of percentage points established by the lender. After the introductory period, the index and margin are generally added together to determine the new interest rate, subject to any applicable caps.
What are rate caps?
Rate caps limit how much the interest rate can change. An ARM may have an initial adjustment cap, a cap for each later adjustment and a lifetime cap that limits how high the rate can rise over the entire loan term. The specific caps vary by loan.
Will my total mortgage payment remain the same during the fixed period?
The principal-and-interest portion generally remains stable during the initial fixed-rate period. However, the total payment may still change if property taxes, homeowners insurance, mortgage insurance or other escrow expenses change.
Who may benefit from an ARM?
An ARM may be worth considering for borrowers who expect to sell the home, relocate, refinance or pay off the mortgage before the initial fixed period expires. However, refinancing is not guaranteed and may involve new closing costs, so borrowers should also be prepared for the possibility that the rate and payment will adjust.
Is an ARM riskier than a fixed-rate mortgage?
An ARM involves more uncertainty because the future interest rate and payment may change. A fixed-rate mortgage provides greater payment predictability, while an ARM may provide a lower initial rate in exchange for accepting the risk of future increases.
What should I review before choosing an ARM?
Review the length of the introductory period, adjustment frequency, index, margin, rate caps, maximum possible payment and whether the rate can decrease. These details should appear in the loan disclosures and Loan Estimate.
Can I refinance an ARM into a fixed-rate mortgage?
Yes, qualified homeowners may be able to refinance into a fixed-rate mortgage. Approval, interest rates and closing costs will depend on market conditions, property value and the borrower’s financial qualifications at the time of refinancing.
How do I know whether an ARM is right for me?
The right choice depends on your budget, future plans, risk tolerance and how long you expect to keep the mortgage. A mortgage professional can compare the initial payment, maximum possible payment and long-term costs of adjustable- and fixed-rate options.