What Is An Adjustable-Rate Mortgage ARM?

See the table below for a detailed breakdown of how each loan type moved. We’re transparent about how we are able to bring quality content, competitive rates, and useful tools to you by explaining how we make money. Two key factors known as “index” and “margin” determine your ARM’s interest rate. When interest rates are falling, the interest rate on an ARM mortgage will decline without the need for you to refinance the mortgage. To make sure you can repay the loan, some ARM programs require that you qualify at the maximum possible interest rate based on the terms of your ARM loan. Another key characteristic of ARMs is whether they are conforming or nonconforming loans.

What Is An Adjustable-Rate Mortgage?

Consider consulting with a professional financial advisor to review the mortgage options for your specific situation. The main advantage of a fixed-rate loan is that the borrower is protected from sudden and potentially significant increases in monthly mortgage payments if interest rates rise. If you’re buying a short-term home and plan to move away or upsize in a few years, an ARM could save you money. You could benefit from the lower rate and payment, then sell your home before the rate adjusts. An ARM can also be helpful in a rising-rate market where high fixed rates are pricing buyers out of the homes they wanted. Buying a home requires more than just saving up to get a mortgage and finding your perfect home.

Consider different types of home loans

• Even with a fixed interest rate, the total amount of interest you’ll pay also depends on the mortgage term.
• Typically, ARM loan rates start lower than their fixed-rate counterparts, then adjust upwards once the introductory period is over.
• This means that you benefit from falling rates and also run the risk if rates increase.
• The most obvious advantage is that a low rate, especially the intro or teaser rate, will save you money.
• The primary benefit of a fixed-rate mortgage is the stability it offers.
• Use our interactive Loan Estimate to double-check that all the details about your loan are correct.
• 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.

Last month on the 2nd, the average rate on a 30-year fixed mortgage was lower, at 6.78 percent. Deciding between an adjustable-rate mortgage and a fixed-rate mortgage is an important consideration. As you explore your options, think about all the factors that could make an ARM ideal for your situation, or could make an ARM a challenge for you in the future. And if you are on a tight budget, you could face financial struggles if interest rates rise. Some ARMs are structured so that interest rates can nearly double in just a few years.

Is an adjustable rate a bad idea?

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.

Payment option ARM loans

The main benefit of an ARM is the lower initial interest rate, which can result in lower monthly payments during the initial period. This can make ARMs attractive for buyers who plan to sell or refinance before the adjustable period begins. ARMs typically start with a lower initial interest rate compared to fixed-rate mortgages.

Interest-only ARM loans

Keep in mind that if you cannot afford your payments, you risk losing your home to foreclosure. Once the ARM’s fixed-rate period ends, changes happen periodically and what you pay one month could increase the next month. These regular adjustments can be harder to predict and budget for, so an ARM may not be a good option if, for example, you have an unpredictable income or struggle with budgeting in general.

How to get the best mortgage rate

• More recently, rates have been driven by factors like inflation, the election and geopolitical developments abroad.
• ARMs may offer you flexibility, but they don’t provide you with any predictability as fixed-rate loans do.
• 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.
• A fixed-rate mortgage comes with a fixed interest rate for the entirety of the loan.
• 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.

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.

What Is an Adjustable-Rate Mortgage (ARM)?

• For example, a hybrid ARM may remain fixed for the first 5 years, and then adjust every year after that.
• Interest-only ARMs are adjustable-rate mortgages in which the borrower only pays interest (no principal) for a set period.
• Before getting an ARM, you should also get an idea of where rates might head in the coming years.
• That’s because ARM intro rates are typically lower than fixed rates.
• For example, if the index is 5% and the margin is 2%, the interest rate on the mortgage adjusts to 7%.
• These can offer a lower payment that covers just the interest, or possibly not even all the interest due, for a period of time.
• Rates will depend on your mortgage lender, but in general, lenders reward a shorter initial rate period with a lower intro rate.
• However, if you’re going to stay in your home for decades, an ARM can be risky.
• This can help borrowers lower their costs and the outset and potentially afford more expensive homes on the same budget.

If the balance rises too much, your lender might recast the loan and require you to make much larger, and potentially unaffordable, payments. For example, a 2/28 ARM features a fixed rate for two years followed by a floating rate for the remaining 28 years. In comparison, a 5/1 ARM has a fixed rate for the first five years, followed by a variable rate that adjusts every year (as indicated by the number one after the slash). Likewise, a 5/5 ARM would start with a fixed rate for five years and then adjust every five years.

Pros and Cons of Fixed-Rate Mortgages

• ARMs come with rate caps that insulate you from possible steep year-to-year increases in monthly payments.
• Adjust the graph below to see historical mortgage rates tailored to your loan program, credit score, down payment and location.
• Once the ARM’s fixed-rate period ends, changes happen periodically and what you pay one month could increase the next month.
• Occasionally the adjustment period is only six months, which means after the initial rate ends, your rate could change every six months.
• But because the rate changes with ARMs, you’ll have to keep juggling your budget with every rate change.
• 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.

That’s because you’re probably already getting the best deal available. 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. Monthly payments on a 5/1 ARM at 6.25 percent would cost about $616 for each $100,000 borrowed over the initial five years. 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.

The risk of ARMs

An adjustable-rate mortgage makes sense if you have time-sensitive goals that include selling your home or refinancing your mortgage before the initial rate period ends. You may also want to consider applying the extra savings to your principal to build equity faster, with the idea that you’ll net more when you sell your home. Before the 2008 housing crash, lenders offered payment option ARMs, giving borrowers several options for how they pay their loans. The choices included a principal and interest payment, an interest-only payment or a minimum or “limited” payment. As mentioned above, a hybrid ARM is a mortgage that starts out with a fixed rate and converts to an adjustable-rate mortgage for the remainder of the loan term. The loan starts with a fixed interest rate for a few years (usually three to 10), and then the rate adjusts up or down on a preset schedule, such as once per year.

Not every lender charges prepayment penalties, and the length of time for the penalty may vary. Before choosing an ARM, be sure to ask your lender if you would incur any penalties should you decide to pay your loan off early. The table below is updated daily with current mortgage rates for the most common types of home loans. Adjust the graph below to see historical mortgage rates tailored to your loan program, credit score, down payment and location. The 30-year mortgage, which offers the lowest monthly payment, is often a popular choice. However, the longer your mortgage term, the more you will pay in overall interest.

• Then, the rate adjusts every year after that, which is what the second number indicates.
• If you’re buying a short-term home and plan to move away or upsize in a few years, an ARM could save you money.
• While we strive to provide a wide range of offers, Bankrate does not include information about every financial or credit product or service.
• 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.
• 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.
• After all, why wouldn’t you lock in an ultra-affordable rate and payment for the life of the loan?
• The ARM index is often a benchmark rate such as the prime rate, the LIBOR, the Secured Overnight Financing Rate (SOFR), or the rate on short-term U.S.
• Lower initial payments can help you more easily qualify for a loan.

But payments will balloon later on, and when this happens you will still have the full loan balance to pay off. Keep in mind that adjustable mortgage rate don’t always increase. If the index rate to which your loan is tied has fallen by the time your loan adjusts, your rate and payment also have to potential to go down. The initial period of an ARM where the interest rate what is an adjustable rate mortgage remains the same typically ranges from one year to seven years. An ARM may make good financial sense if you only plan to live in your house for that amount of time or plan to pay off your mortgage early, before interest rates can rise. While there are rate caps in place to protect you, that doesn’t mean your rate and payment can’t increase significantly over time.

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.

At the current average rate, you’ll pay $665.97 per month in principal and interest for every $100,000 you borrow. The average rate for a 15-year fixed mortgage is 6.29 percent, down 1 basis point from a week ago. At the conclusion of its latest meeting on Dec. 18, the Federal Reserve announced another quarter-point rate cut — the third cut in a row. Although the Fed has cut interest rates 100 basis points since September, mortgage rates have only risen, up 0.71 percentage points since September’s low, according to Bankrate data.

Advantages of Fixed-Rate Mortgages

Generally, the initial interest rate on an ARM mortgage is lower than that of a comparable fixed-rate mortgage. After that period ends, interest rates — and your monthly payments — can rise or fall. Unlike ARMs, traditional or fixed-rate mortgages carry the same interest rate for the life of the loan, which might be 10, 20, 30, or more years.

Adjustable-rate mortgage FAQ

• If broader interest rates decline, the interest rate on a fixed-rate mortgage will not decline.
• 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.
• Fixed-rate mortgages have an interest rate that remains the same throughout the term of the mortgages, while ARMS have interest rates that can change based on broader market trends.
• If you don’t think you can comfortably afford the new monthly payment once the adjustment goes through, you may have to cut costs in other areas.

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.

Rate Caps

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.

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.

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.

Occasionally the adjustment period is only six months, which means after the initial rate ends, your rate could change every six months. The best way to get an idea of how an ARM can adjust is to follow the life of an ARM. For this example, we assume you’ll take out a 5/1 ARM with 2/2/6 caps and a margin of 2%, and it’s tied to the Secured Overnight Financing Rate (SOFR) index, with an 5% initial rate. Borrowers have many options available to them when they want to finance the purchase of their home or another type of property. While the former provides you with some predictability, ARMs offer lower interest rates for a certain period before they begin to fluctuate with market conditions.

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.

Lower initial payments can help you more easily qualify for a loan. ARM rates are often (but not always) lower than 30-year fixed rates. This means that while you’re in the fixed-rate period of your ARM, you could have a lower monthly payment, giving you more space in your budget for other necessities. ARMs generally have lower interest rates, at least initially, compared to fixed-rate mortgages.

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.

This can make it hard to budget and plan for and could strain your finances. If you check the respective index and see trends are going up or down, you’ll have a good idea whether your rate will increase or decrease at the next adjustment point. 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. With these options, you’ll pay the same rate for the first five or seven years of the loan. The first number, five, is how long the fixed interest term will last on your loan. This means you’ll pay the same interest rate for the first five years of your loan.

This is different from a fixed-rate mortgage, which locks in your rate for the entire life of your loan. For example, if you have a 30-year fixed-rate mortgage, you’d pay the same rate for all 30 years. The “limited” payment allowed you to pay less than the interest due each month — which meant the unpaid interest was added to the loan balance. When housing values took a nosedive, many homeowners ended up with underwater mortgages — loan balances higher than the value of their homes. The foreclosure wave that followed prompted the federal government to heavily restrict this type of ARM, and it’s rare to find one today. A payment-option ARM, however, could result in negative amortization, meaning the balance of your loan increases because you aren’t paying enough to cover interest.

If broader interest rates decline, the interest rate on a fixed-rate mortgage will not decline. If you want to take advantage of lower interest rates, you would have to refinance your mortgage, which will entail closing costs. Before getting an ARM, you should also get an idea of where rates might head in the coming years.

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.

After all, why wouldn’t you lock in an ultra-affordable rate and payment for the life of the loan? However, ARM loans often grow in popularity when rates are rising. That’s because ARM intro rates are typically lower than fixed rates. This can help borrowers lower their costs and the outset and potentially afford more expensive homes on the same budget. The caps on your adjustable-rate mortgage are the first line of defense against massive increases in your monthly payment during the adjustment period. They come in handy, especially when rates rise rapidly — as they have the past year.

An ARM doesn’t make sense if you’re buying or refinancing your “forever home” or if you can only afford the teaser rate.

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.