What Is An Adjustable-Rate Mortgage?

With nearly two decades in journalism, Dori Zinn has covered loans and other personal finance topics for the better part of her career. She loves helping people learn about money, whether that’s preparing for retirement, saving for college, crafting.

With nearly two decades in journalism, Dori Zinn has covered loans and other personal finance topics for the better part of her career. She loves helping people learn about money, whether that’s preparing for retirement, saving for college, crafting.

With nearly two decades in journalism, Dori Zinn has covered loans and other personal finance topics for the better part of her career. She loves helping people learn about money, whether that’s preparing for retirement, saving for college, crafting.

With nearly two decades in journalism, Dori Zinn has covered loans and other personal finance topics for the better part of her career. She loves helping people learn about money, whether that’s preparing for retirement, saving for college, crafting.

Chris Jennings is a writer and editor with more than seven years of experience in the personal finance and mortgage space. He enjoys simplifying complex mortgage topics for first-time homebuyers and homeowners alike. His work has been featured in a n.

Chris Jennings is a writer and editor with more than seven years of experience in the personal finance and mortgage space. He enjoys simplifying complex mortgage topics for first-time homebuyers and homeowners alike. His work has been featured in a n.

Chris Jennings is a writer and editor with more than seven years of experience in the personal finance and mortgage space. He enjoys simplifying complex mortgage topics for first-time homebuyers and homeowners alike. His work has been featured in a n.

Chris Jennings is a writer and editor with more than seven years of experience in the personal finance and mortgage space. He enjoys simplifying complex mortgage topics for first-time homebuyers and homeowners alike. His work has been featured in a n.

| Loans & Mortgages Editor

Updated: Sep 29, 2023, 9:36am

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Buying a home requires more than just saving up to get a mortgage and finding your perfect home. It also includes finding the right type of mortgage that’s best for your budget—loan term, interest rate and monthly payment all play a factor in what you can reasonably afford. An adjustable-rate mortgage (ARM) might be something to consider as you’re exploring different borrowing options.

What Is an Adjustable-Rate Mortgage?

An ARM, sometimes called a variable-rate mortgage, is a mortgage with an interest rate that changes or fluctuates during your loan term. Other loans typically have a fixed rate, where the interest rate doesn’t change over the life of the loan.

Usually, ARMs start off with a lower interest rate compared to fixed-rate mortgage rates but can increase (or decrease) over time.

How Does an Adjustable-Rate Mortgage Work?

With a fixed-rate loan, you’ll pay one set amount every month for the duration of your loan term, like 15, 20 or 30 years. If you keep the same loan with the same lender, your mortgage payment won’t change.

Adjustable-rate mortgages, on the other hand, have fluctuating interest rates. In most cases, the rate will stay the same for a set amount of time based on the lender and type of ARM you choose. This could mean the rate is the same for the first month or up to five years. For example, if you get a 5/1 ARM, your rate will remain fixed for the first five years and then will become variable for the rest of the term.

Based on the terms you agreed to with your mortgage lender, your payment could change from one month to the next, or you might not see a change for many months or even years.

Types of ARMs

There are a few different types of ARMs: hybrid, interest-only and payment option.

Hybrid

If you’ve ever seen a buying option like 5/1 or 7/1 ARM, that’s a hybrid adjustable-rate mortgage. For these types of loans, the interest rate is fixed for a set number of years—like three, five or seven, for example. After that initial period, the rate adjusts annually or according to the terms set by the lender, which might be more or less frequent.

The first number is how long the interest rate is fixed and the second number is how frequently that rate changes after the initial period. For instance, using our same example from above, a 5/1 ARM means the rate is fixed for five years and then variable every year after that.

Interest-Only

An interest-only (I-O) mortgage means you’ll only pay interest for a set amount of years before you get the chance to start paying down the principal balance. With a traditional fixed-rate mortgage, you’ll pay a portion of the principal and some of the interest every month but the total payment you make never changes.

With an I-O home loan, you’ll have smaller monthly payments that increase over time as you eventually start to pay down the principal balance. The longer your I-O period, the larger your monthly payments will be after the I-O period ends. Most I-O periods last between three and 10 years.

Payment Option

With a payment option ARM, you have a few different ways to pay back your loan.

• Traditional: This method includes a traditional breakdown of principal and interest. It’s similar to a fixed-rate mortgage, where you pay a part of your principal and interest every month. This is the only option to reduce how much you owe on your loan.
• Interest-only: With this loan, you have the option to pay only the interest for a certain period of time, typically a few years, and then you pay both the interest and principal for the remainder of the loan. While paying only the interest does sound attractive, it can add up costs on the back-end when it’s time to start paying off your loan balance.
• Minimum (or limited): You can make the minimum payment for this one, but any interest you don’t pay gets added onto the principal balance of the loan, which means you’re essentially paying interest on interest. This option could be hard on your finances—because regardless of your financial circumstance when your loan term ends, you’re responsible for the total balance due.

Pros and Cons of an ARM

While an ARM is one way to repay your home loan, it’s not always the best way for everyone. Make sure to weigh the pros and cons before choosing this option.

Pros of an ARM

• Lower initial rate: ARMs tend to have lower initial interest rates compared to fixed-rate mortgages. If you qualify for a low-interest ARM, you could pay a lot less in interest upfront.
• Fluctuation could mean a drop in interest: Even though there’s a chance your interest rate could go up, it could also go down. Since the rate is based on a benchmark, you could see a lower interest rate than what fixed-rate loans offer.
• Payment caps: While an interest rate may go up, ARMs have payment caps, which limit how much your lender can increase the rate. The caps also control how many times a lender can bump up the rate. So, while your rate is likely to increase at some point, you might not face as big of an increase as you think.

Cons of an ARM

• Potential rise in rates: After the initial period, your interest rate is set to rise, usually annually. If you aren’t prepared for the adjustment, you could face a payment increase that you may not be able to afford.
• Complicated structures: There isn’t just one type of ARM—there are many. Because of this, it can get confusing. If you don’t understand all the moving parts and do your research, you could wind up paying more than you expected.

ARM vs. Fixed-Rate Mortgage: Which One Is Right For You?

You might want an ARM if:

• This isn’t a long-term home. If you don’t think you’re going to stick around for the long run, you can take advantage of your home’s low initial interest rate and sell it before the rate adjusts to a potentially higher one.
• You expect to earn more. A fluctuating interest rate is best for borrowers who are financially comfortable to handle the uptick in costs. If you think your income is going to go up within the next few years, your bank account might be able to handle an ARM. Along with that, if you’re a high earner right now, you could make extra payments toward your loan and pay it off early—before the new interest rate starts. But make sure this is OK with your lender, so you don’t get hit with a prepayment penalty.

You may want a fixed-rate mortgage instead if:

• You’re buying your forever home. For borrowers who are thinking about a home purchase they plan to keep for a long time, a fluctuating interest rate might not be your best option. If your goal is to live in the home for many years to come, a fixed-rate mortgage might be better for you since it is dependable and consistent.
• You have a strict budget. Fixed-rate loans mean you’re paying the same amount every month, so you know exactly what you’re responsible for. ARMs might be too much for your finances if your budget is tight, even if the change is a few years down the road.

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With nearly two decades in journalism, Dori Zinn has covered loans and other personal finance topics for the better part of her career. She loves helping people learn about money, whether that’s preparing for retirement, saving for college, crafting a budget or starting to invest. Her work has been featured in the New York Times, Wall Street Journal, CNN, Yahoo, TIME, AP, CNET, New York Post and more.

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