What Is An Adjustable-Rate Mortgage ARM?

Homeowners can plan their budgets without worrying about interest rate changes. This predictability is especially valuable in times of economic uncertainty. At Bankrate we strive to help you make smarter financial decisions. While we adhere to stricteditorial integrity, this post may contain references to products from our partners.

Pros of an Adjustable-Rate Mortgage

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.

CFPB Files Lawsuit to Stop Illegal Kickback Scheme to Steer Borrowers to Rocket Mortgage

If you cannot afford your payments, you could lose your home to foreclosure. If rates decrease later, your monthly mortgage payment could go down. If rates start trending down in a few years, you could potentially have a lower rate than what you started with. An adjustable-rate mortgage has an interest rate that can change.

• Two key factors known as “index” and “margin” determine your ARM’s interest rate.
• ARMs typically start with a lower initial interest rate compared to fixed-rate mortgages.
• These mortgages can often be very complicated to understand, even for the most seasoned borrower.
• A mortgage calculator can show you the impact of different rates and terms on your monthly payment.
• The lender then applies a margin on top of that (it’s the lender’s profits).
• The stable rate and payment make FRMs a safer option for homeowners because they never risk their payments rising and becoming unaffordable.

Pros and Cons of Fixed-Rate Mortgages

This allows you to pay lower monthly payments until you decide to sell again. ARMs are also called variable-rate mortgages or floating mortgages. The interest rate for ARMs is reset based on a benchmark or index, plus an additional spread called an ARM margin. The primary benefit of a fixed-rate mortgage is the stability it offers.

Pros of an adjustable-rate mortgage

The average rate on a 5/1 adjustable rate mortgage is 6.25 percent, ticking up 4 basis points over the last week. Rates rose significantly in 2022, making an adjustable-rate mortgage a great option for many would-be homeowners and refinancers. If your plans are to settle in and plant roots for an extended period of time, or the uncertainty of an ARM is frightening, you may be better suited for a fixed-rate mortgage. The big difference between a fixed-rate mortgage (FRM) and an adjustable-rate mortgage (ARM) is that FRMs have a fixed interest rate and payment for the entire life of the loan. When you opt for an FRM, your rate and payment can never change unless you decide to refinance into a new mortgage loan.

Why ARMs are popular right now

They’re advantageous in certain situations, but compared to their fixed-rate counterparts, their unique interest rate structure can be difficult for some borrowers to understand. Eligible military borrowers have extra protection in the form of a cap on yearly rate increases of 1 percentage point for any VA ARM product that adjusts in less than five years. Previous attempts to introduce such loans in the 1970s were thwarted by Congress due to fears that they would leave borrowers with unmanageable mortgage payments.

Adjustable-rate mortgage vs. 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. 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.

Can I refinance an ARM to a fixed-rate mortgage?

For these averages, APRs and rates are based on no existing relationship or automatic payments. Monthly payments on a 15-year fixed mortgage what is an adjustable rate mortgage at that rate will cost $860 per $100,000 borrowed. Our experts have been helping you master your money for over four decades.

What is an adjustable-rate mortgage (ARM)?

There are various features that come with these loans that you should be aware of before you sign your mortgage contracts, such as caps, indexes, and margins. It’s also possible to secure an interest-only (I-O) ARM, which essentially would mean only paying interest on the mortgage for a specific time frame, typically three to 10 years. Once this period expires, you are then required to pay both interest and the principal on the loan. Mortgages allow homeowners to finance the purchase of a home or other piece of property.

How does an ARM loan work?

One drawback is that fixed-rate mortgages often have higher initial interest rates compared to adjustable-rate mortgages. Additionally, if market interest rates decline, homeowners with fixed-rate mortgages will not benefit from the lower rates unless they refinance their loans. Bankrate follows a strict editorial policy, so you can trust that we’re putting your interests first.

Pros And Cons Of An Adjustable-Rate Mortgage (ARM)

There’s also the need to verify that your current finances can accommodate a higher payment down the road — even if you plan to move before the lower-rate period ends. It can be confusing to understand the different numbers detailed in your ARM paperwork. These mortgages can often be very complicated to understand, even for the most seasoned borrower.

Harder To Budget For

They generally have higher interest rates at the outset than ARMs, which can make ARMs more attractive and affordable, at least in the short term. However, fixed-rate loans provide the assurance that the borrower’s rate will never shoot up to a point where loan payments may become unmanageable. The primary risk of ARMs is the potential for significant increases in monthly payments if interest rates rise. This uncertainty can make budgeting difficult and may lead to financial strain if rates increase substantially. Even with a fixed interest rate, the total amount of interest you’ll pay also depends on the mortgage term.

• Weight the pros and cons of a fixed vs. adjustable-rate mortgage, including their initial monthly payment amounts and their long-term interest.
• ARM loan guidelines require a 5% minimum down payment, compared to the 3% minimum for fixed-rate conventional loans.
• After that, the interest rate applied on the outstanding balance resets periodically, at yearly or even monthly intervals.
• A 5/5 ARM is a mortgage with an adjustable rate that adjusts every 5 years.

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.

Is an Adjustable-Rate Mortgage Right For You?

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.

The second number (“1”) represents how often your interest rate could adjust up or down. Using the 5/1 ARM example, after your fixed rate expires, your interest rate could adjust up or down once each year. 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. An ARM may also make sense if you expect to make more income in the future. If an ARM adjusts to a higher interest rate, a higher income could help you afford the higher monthly payments.

When Were ARMs First Offered to Homebuyers?

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.

• Keep in mind, though, that your credit score plays an important role in determining how much you’ll pay.
• She loves helping people learn about money, whether that’s preparing for retirement, saving for college, crafting a budget or starting to invest.
• 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.
• Your interest rate can be either fixed or adjustable — sometimes called variable.
• The initial period of an ARM where the interest rate remains the same typically ranges from one year to seven years.
• Fixed-rate mortgages make up almost the entire mortgage market when rates are low.

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.

There are certain features that might entice you to choose an ARM over a fixed-rate mortgage. There are benefits and drawbacks to consider before deciding if an adjustable-rate mortgage (ARM) is right for you. Yes, you can refinance your ARM to a fixed-rate loan as long as you qualify for the new mortgage. There are several moving parts to an adjustable-rate mortgage, which make calculating what your ARM rate will be down the road a little tricky. 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. Opting to pay the minimum amount or just the interest might sound appealing.

Borrowers with fixed-rate loans know what their payments will be throughout the life of the loan because the interest rate never changes. But because the rate changes with ARMs, you’ll have to keep juggling your budget with every rate change. In most cases, the first number indicates the length of time that the fixed rate is applied to the loan, while the second refers to the duration or adjustment frequency of the variable rate. The average rate for a jumbo mortgage is 7.02 percent, an increase of 7 basis points over the last week. This time a month ago, the average rate on a jumbo mortgage was lower at 6.87 percent. First, if you intend to live in the home only a short period of time, you may want to take advantage of the lower initial interest rates ARMs provide.

• 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.
• Make sure you understand the terms of the ARM you’re considering, including the maximum amount your rate and payment can increase.
• Our goal is to give you the best advice to help you make smart personal finance decisions.
• The second number (“1”) represents how often your interest rate could adjust up or down.
• A major advantage of an ARM is that it generally has cheaper monthly payments compared to a fixed-rate mortgage, at least initially.
• This means that if market conditions lead to a rate hike, you’ll end up spending more on your monthly mortgage payment.

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.

Traditional lenders offer fixed-rate mortgages for a variety of terms, the most common of which are 30, 20, and 15 years. Still, borrowers considering an ARM should always plan for the worst-case scenario. Make sure you understand the terms of the ARM you’re considering, including the maximum amount your rate and payment can increase.

If rates are up when your ARM adjusts, you’ll end up with a higher rate and a higher monthly payment, which could put a strain on your budget. If you’re in the market for a home loan, one option you might come across is an adjustable-rate mortgage. These mortgages come with fixed interest rates for an initial period, after which the rate moves up or down at regular intervals for the remainder of the loan’s term. Notably, some ARMs have payment caps that limit how much the monthly mortgage payment can increase in dollar terms. That can lead to a problem called negative amortization if your monthly payments aren’t sufficient to cover the interest rate that your lender is changing. With negative amortization, the amount that you owe can continue to increase even as you make the required monthly payments.

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.

Rate adjustment periods define how often the interest rate on an ARM can change after the initial fixed period. Common adjustment periods include annually (1-year ARM) or every six months. The terms of the rate adjustment are outlined in the mortgage contract. Most mainstream ARM loan payments include both principal and interest. The only time you won’t pay principal on an ARM is if you opt for a special product like an interest-only or payment-option ARM. These can offer a lower payment that covers just the interest, or possibly not even all the interest due, for a period of time.

You can use those extra funds to pay off other debt, invest in your future or make larger payments on your mortgage principal to pay off the loan faster. In the recent past, ARMs have charged as much as a full percentage point less than fixed mortgages. The increase is directly related to the rise in fixed mortgage rates, which were nearing 8 percent last fall, a level not seen since 2000. With less purchasing power at higher fixed rates, the lower introductory rates attached to ARMs have started to look much more appealing. However, if you’re going to stay in your home for decades, an ARM can be risky.

We continually strive to provide consumers with the expert advice and tools needed to succeed throughout life’s financial journey. When you’ve decided which type of mortgage is best for you, reach out to a lender to get started right away. With a payment option ARM, you have a few different ways to pay back your loan. You’ll have a fixed rate for the first decade, and then the rate changes once per year after that. Yes, if your ARM loan comes with a “conversion option.” Lenders may offer this choice with conditions and potentially an extra cost, allowing you to convert your ARM loan to a fixed-rate loan. You may need a score of 640 for a conventional ARM, compared to 620 for fixed-rate loans.

Conforming loans are those that meet the standards of government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. They are packaged and sold off on the secondary market to investors. Nonconforming loans, on the other hand, aren’t up to the standards of these entities and aren’t sold as investments. “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. “As expected, the Fed lowered rates again by 0.25 percent — it also lowered its expectations for rate cuts in 2025,” says Melissa Cohn, regional vice president of William Raveis Mortgage.

If you are considering an ARM, calculate the payments for different scenarios to ensure you can still afford them up to the maximum cap. For instance, if you take out a 5/1 ARM with an index at 3% and a margin of 2%, your intro rate is 5%. Let’s say when the intro period ends, the index has dropped to 1.5% — your rate for the following year will be 3.5% (1.5% index + 2% margin). We’re the Consumer Financial Protection Bureau (CFPB), a U.S. government agency that makes sure banks, lenders, and other financial companies treat you fairly.