An adjustable-rate mortgage (ARM) is a home loan with an interest rate that starts lower than a fixed-rate mortgage but can change periodically after an initial fixed period. Unlike a fixed-rate loan—where the interest rate and monthly payment remain constant—an ARM’s rate resets according to market conditions, causing payments to rise or fall within preset limits.
Lenders offer ARMs to manage interest-rate risk while attracting borrowers seeking lower initial payments. ARMs appeal to buyers planning to move or refinance before rate adjustments begin. Eligibility typically requires good credit, a low debt-to-income ratio and a clear ownership timeline.
The teaser rate is a discounted fixed rate—often 3–10 years—set at closing. It’s lower than prevailing fixed rates to reduce monthly payments early in the loan term.
After the teaser period, the rate resets at defined intervals (commonly annually or every six months). Each reset links to a financial index plus a margin to determine the new rate.
The index is a benchmark rate (SOFR, COFI, MTA). The margin is a fixed percentage added to the index. For example, if SOFR is 2.5% and the margin is 2%, the new rate becomes 4.5%.
Caps limit how much the interest rate can rise. Typical structures include:
Hybrid ARMs combine a fixed-rate period (5, 7 or 10 years) with annual adjustments thereafter. A 5/1 ARM, for example, has a fixed rate for five years, then adjusts once per year.
A 1-year ARM resets every year from the start, reflecting current market rates with each adjustment.
Interest-only ARMs allow borrowers to pay only interest for a set time, then amortize principal and interest. Payment-option ARMs offer multiple payment choices—minimum, interest-only or fully amortizing—each carrying unique risks.
Ideal for borrowers who plan to sell or refinance within the fixed period. Less suited for long-term homeowners or those with tight budgets sensitive to payment fluctuations.
Short term (3–10 years): ARMs often cost less. Long term: fixed rates may be cheaper if rates rise.
Fixed-rate loans offer certainty; ARMs offer flexibility and potential savings if rates fall.
Choose based on your comfort with rate risk, predictions for interest trends and how long you’ll keep the property.
At reset, the lender adds the index value to your margin. For example, if COFI is 1% and your margin is 2.5%, the new rate equals 3.5% (subject to caps).
Online ARM calculators display payment changes over time. Amortization schedules show principal vs. interest breakdown at each rate.
Sarah buys a $350,000 home with a 5/1 ARM at 3.5%. Her payment: $1,571/month for five years—lower than a 4.5% fixed rate ($1,773/month).
Year 6: Rate rises to 4.5% (capped +1%), payment $1,777. Year 7: Rate resets to 5.5%, payment $1,995. Caps prevent jumps above 2% per year and 5% lifetime.
If rates climb beyond her budget or she plans to stay long-term, refinancing into a fixed-rate mortgage can lock in predictable payments.
Ideal for those relocating or upgrading within the ARM’s fixed period.
Investors using rental income or planning quick flips can capitalize on low initial rates.
Homeowners seeking lower rates and planning a second refinance before adjustments begin.
Compare index types, margin values, cap structures and introductory rates side by side. Request loan estimates and use identical scenarios for accuracy.
Most ARMs allow refinancing or conversion into a fixed-rate mortgage. Evaluate closing costs, remaining term and current market rates before deciding.
ARMs offer lower initial rates and flexibility but carry adjustment risk. Understand terms, caps and your ownership horizon before choosing.
Use online ARM calculators, consult mortgage advisors and explore government-backed loan options like FHA ARMs. Further reading: Federal Reserve index publications, mortgage industry blogs and lender rate sheets.
