Adjustable-Rate Mortgage Guide How ARM Loans Work

On the loan estimate you receive from your lender, it will show you how high your monthly payment could go if your rate hits the maximum. An adjustable-rate mortgage is a home loan with an interest rate that changes during the loan term. Most ARMs feature low initial or “teaser” ARM rates that are fixed for a set period of time lasting three, five or seven years. Yes, their favorable introductory rates are appealing, and an ARM could help you to get a larger loan for a home. However, it’s hard to budget when payments can fluctuate wildly, and you could end up in big financial trouble if interest rates spike, particularly if there are no caps in place. 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.

Understand your Loan Estimate

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, but 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. In most cases, you can choose the type of mortgage loan that best suits your needs.

ARM terms defined

For example, if you plan on only living in the home for around five years, you might feel comfortable taking on a 7/6 ARM, since the rate won’t adjust for seven years. Since ARMs can have lower payments at the start, they can offer more flexibility — at least toward the beginning of the mortgage. This could give you more cash to invest in other ventures or achieve other financial goals. The lender then applies a margin on top of that (it’s the lender’s profits). This is how it will come to your initial mortgage rate, which you’ll keep for the first few years of the loan.

Key features of adjustable-rate mortgages

A fixed-rate mortgage is a type of home loan where the interest rate remains constant throughout the entire term of the loan. This means that the monthly payments for principal and interest will not change, providing stability and predictability for homeowners. If you’re confident you’ll be moving before the fixed-rate period ends, an ARM could be a great choice. You’ll enjoy the perks of a cheaper introductory rate and payment, and then move before your low rate expires. If your plans change and you no longer plan to move, refinancing to a fixed-rate mortgage could be a viable option.

Who should consider an adjustable-rate mortgage?

Fixed-rate mortgages are the most popular choice for mortgage borrowers. The stable rate and payment make FRMs a safer option for homeowners because they never risk their payments rising and becoming unaffordable. The traditional 30-year fixed-rate mortgage is the most common type of home loan, followed by the 15-year fixed-rate mortgage. 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.

How does the Federal Reserve affect mortgage rates?

Rate caps are especially important to understand, as they limit how much your interest rate and mortgage payment can go up throughout the adjustment period of your loan. It’s also important to understand how adjustable mortgage rates work when it comes time for your rate what is adjustable rate mortgage to adjust. There are three kinds of “rate caps” that limit the amount your rate can increase each time it changes. Common ARM mortgage options include the 3/1, 5/1, 7/1, and 10/1 ARM. With a 5/1 ARM, you would have an introductory fixed-rate period of five years.

Pros and Cons of Adjustable-Rate Mortgages (ARMs)

• The stable rate and payment make FRMs a safer option for homeowners because they never risk their payments rising and becoming unaffordable.
• ARMs come with rate caps that insulate you from possible steep year-to-year increases in monthly payments.
• But because the rate changes with ARMs, you’ll have to keep juggling your budget with every rate change.
• A mortgage calculator can show you the impact of different rates and terms on your monthly payment.
• Your lender will also have rate caps in place that will determine how much your rate can increase each period and how high your rate can go over the life of your loan.
• They come in handy, especially when rates rise rapidly — as they have the past year.
• Adjustable-rate mortgages, on the other hand, have fluctuating interest rates.

However, the low introductory rate on an ARM could help lower your payment at the outset and boost your home-buying power. Usually, ARMs start off with a lower interest rate compared to fixed-rate mortgage rates but can increase (or decrease) over time. An interest-only mortgage is when you pay only the interest as your monthly payments for several years. A fixed-rate mortgage has an interest rate that remains unchanged throughout the loan’s term. (However, the proportion of the principal and interest will change).

Key Differences Between Fixed and Adjustable-Rate Mortgages

Choosing between fixed and adjustable-rate mortgages depends on your financial goals, risk tolerance, and market conditions. Fixed-rate mortgages offer stability and predictability, while ARMs provide lower initial payments and potential savings. Consulting with a financial advisor or mortgage specialist can provide personalized guidance tailored to your specific financial situation and goals.

How ARM rate caps work

Fixed and adjustable-rate mortgages choosing depends on your financial goals and risk tolerance. Fixed-rate mortgages offer stable interest rates and predictable monthly payments, ideal for long-term planning and security. Adjustable-rate mortgages (ARMs), on the other hand, start with lower initial interest rates, which can adjust periodically based on market conditions.

What is a good mortgage interest rate?

When you get a mortgage, you’ll pay interest on the money you borrow. Your interest rate can be either fixed or adjustable — sometimes called variable. This booklet helps you understand important loan documents your lender gives you when you apply for an adjustable-rate mortgage (ARM). 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.

Cons of an adjustable-rate mortgage

• Before the 2008 housing crash, lenders offered payment option ARMs, giving borrowers several options for how they pay their loans.
• ARMs generally have lower interest rates, at least initially, compared to fixed-rate mortgages.
• This is how it will come to your initial mortgage rate, which you’ll keep for the first few years of the loan.
• There are certain features that might entice you to choose an ARM over a fixed-rate mortgage.
• Your mortgage loan officer can share their thoughts with you on this, but it’s also a good idea to do your own research and understand what kind of trends you should be watching.
• So with a 5/1 ARM, you have a 5-year intro period and then 25 years during which your rate and payment can adjust each year.

ARM loan guidelines require a 5% minimum down payment, compared to the 3% minimum for fixed-rate conventional loans. Always read the adjustable-rate loan disclosures that come with the ARM program you’re offered to make sure you understand how much and how often your rate could adjust. ARMs have been around for several decades, with the option to take out a long-term house loan with fluctuating interest rates first becoming available to Americans in the early 1980s. Unlike fixed-rate borrowers, you won’t have to make a trip to the bank or your lender to refinance when interest rates drop.

• ARMs may offer you flexibility, but they don’t provide you with any predictability as fixed-rate loans do.
• There are three kinds of “rate caps” that limit the amount your rate can increase each time it changes.
• 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.
• A fixed-rate mortgage comes with a fixed interest rate for the entirety of the loan.
• A fixed-rate mortgage has an interest rate that remains unchanged throughout the loan’s term.
• Make sure to weigh the pros and cons before choosing this option.
• Mortgage rates have decreased somewhat since earlier this year, with the 30-year fixed-rate loan down from a high of 7.39 percent in May.

The interest rate on an ARM adjusts periodically, typically once a year after the initial fixed-rate period. With an ARM, your rate stays the same for a certain number of years, called the « initial rate period, » then changes periodically. For example, if you have a 5/1 ARM, your introductory rate period is five years, and then your rate will go up or down every year. This means even if mortgage rates are on the rise and you’re set to get an increase, it won’t go up an exorbitant amount. Ask each lender to explain what kind of interest rate cap structure it uses for its ARMs as you shop around. Because ARM rates can potentially increase over time, it often only makes sense to get an ARM loan if you need a short-term way to free up monthly cash flow and you understand the pros and cons.

A month ago, the average rate on a 30-year fixed refinance was lower at 6.75 percent. At the average rate today for a jumbo loan, you’ll pay a combined $666.65 per month in principal and interest for every $100,000 you borrow. Today’s average rate for the benchmark 30-year fixed mortgage is 6.99 percent, a decrease of 2 basis points from a week ago.

1 ARMs

• There are certain features that might entice you to choose an ARM over a fixed-rate mortgage.
• The caps on your adjustable-rate mortgage are the first line of defense against massive increases in your monthly payment during the adjustment period.
• A hybrid ARM is an adjustable rate mortgage that remains fixed for an initial period and then adjusts regularly thereafter.
• “For those expecting a dramatic drop in 30-year mortgage financing rates, 2025 is probably not the year,” says Ken Johnson, Walker Family chair of Real Estate for the University of Mississippi.
• If an ARM adjusts to a higher interest rate, a higher income could help you afford the higher monthly payments.
• The interest rate on ARMs is determined by a fluctuating benchmark rate that usually reflects the general state of the economy and an additional fixed margin charged by the lender.

If your ARM follows the more popular hybrid model, you’ll pay the same low fixed interest rate for the first several years of your loan. This can save you a lot of money if you plan to only stay in your home for a few years and want to take advantage of the lower rate while you live there. Adjustable-rate mortgages, or ARMs, are an alternative choice to conventional mortgages.

How Does an Adjustable-Rate Mortgage (ARM) Work?

They can help you navigate the complexities of mortgage options and make the best decision for your needs. When fixed-rate mortgage rates are high, lenders may start to recommend adjustable-rate mortgages (ARMs) as monthly-payment saving alternatives. Homebuyers typically choose ARMs to save money temporarily since the initial rates are usually lower than the rates on current fixed-rate mortgages.

How Adjustable-Rate Mortgages (ARMs) Work

Bankrate has partnerships with issuers including, but not limited to, American Express, Bank of America, Capital One, Chase, Citi and Discover. Life doesn’t always go as planned, and staying in the home for an extra few years could end up costing you if your rate goes up before you’re able to sell. In this situation, you might want to consider giving yourself a bigger buffer, such as getting a 10/6 ARM. Use our interactive Loan Estimate to double-check that all the details about your loan are correct. If something looks different from what you expected, ask your lender why.

FAQ about adjustable-rate mortgages

If interest rates are high and expected to fall, an ARM will help you take advantage of the drop, as you’re not locked into a particular rate. If interest rates are climbing or a predictable payment is important to you, a fixed-rate mortgage may be the best option for you. A borrower who chooses an ARM could potentially save several hundred dollars a month for the initial term. Then, the interest rate may increase or decrease based on market rates.

An adjustable-rate mortgage, or ARM, is a home loan that has an initial, low fixed-rate period of several years. After that, for the remainder of the loan term, the interest rate resets at regular intervals. When you get a mortgage, you can choose a fixed interest rate or one that changes. Typically, ARM loan rates start lower than their fixed-rate counterparts, then adjust upwards once the introductory period is over. Fixed-rate mortgages make up almost the entire mortgage market when rates are low.

Your mortgage loan officer can share their thoughts with you on this, but it’s also a good idea to do your own research and understand what kind of trends you should be watching. Remember that no one has a crystal ball, and rates could always spike right before your ARM is set to adjust. You also might consider it if you expect your income to grow down the line. If you plan to sell your home or refinance before the ARM’s introductory period is over, you shouldn’t have to worry about the rate adjusting.

This can lead to lower payments in the short term but introduces the risk of rising payments in the future. Understanding the benefits and risks of each type will help you make an informed decision tailored to your financial situation and homeownership plans. Bankrate.com is an independent, advertising-supported publisher and comparison service. We are compensated in exchange for placement of sponsored products and services, or by you clicking on certain links posted on our site. While we strive to provide a wide range of offers, Bankrate does not include information about every financial or credit product or service. The best mortgage rate for you will depend on your financial situation.

A fixed-rate mortgage comes with a fixed interest rate for the entirety of the loan. This means that you benefit from falling rates and also run the risk if rates increase. 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.

Shorter-term mortgages offer a lower interest rate, which allows for a larger amount of principal repaid with each mortgage payment. So, shorter term mortgages usually cost significantly less in interest. In a fixed-rate mortgage, the interest rate is set at the beginning of the loan and does not fluctuate with market conditions. This fixed rate is typically determined based on the borrower’s creditworthiness, the loan term, and prevailing market rates at the time of origination.

Rates will depend on your mortgage lender, but in general, lenders reward a shorter initial rate period with a lower intro rate. Whether an adjustable-rate mortgage is the right choice for you depends on how long you plan to stay in the home, rate trends, your monthly budget, and your level of risk tolerance. Some of the most common terms are 5/1, 7/1, and 10/1 ARMs, but many lenders offer shorter or longer intro periods. Some ARMs, such as 5/6 or 7/6 ARMs, adjust every six months rather than once per year. This is usually a few years —  anywhere from three to 10 — and your rate and payment will stay the same for that entire period.

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. The monthly payments for shorter-term mortgages are higher so that the principal is repaid in a shorter time frame.