What Is An Adjustable-Rate Mortgage?

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.

Adjustable-Rate Mortgage (ARM): What It Is and Different Types

• Deciding between an adjustable-rate mortgage and a fixed-rate mortgage is an important consideration.
• If your plans change and you no longer plan to move, refinancing to a fixed-rate mortgage could be a viable option.
• While there are rate caps in place to protect you, that doesn’t mean your rate and payment can’t increase significantly over time.
• 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 booklet helps you understand important loan documents your lender gives you when you apply for an adjustable-rate mortgage (ARM).
• An adjustable-rate mortgage has an interest rate that can change.
• At Bankrate we strive to help you make smarter financial decisions.
• Borrowers have many options available to them when they want to finance the purchase of their home or another type of property.
• Fixed and adjustable-rate mortgages choosing depends on your financial goals and risk tolerance.

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.

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• Then, the interest rate may increase or decrease based on market rates.
• 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.
• Indeed, adjustable-rate mortgages went out of favor with many financial planners after the subprime mortgage meltdown of 2008, which ushered in an era of foreclosures and short sales.
• The most common initial fixed-rate periods are three, five, seven and 10 years.
• There are benefits and drawbacks to consider before deciding if an adjustable-rate mortgage (ARM) is right for you.

Mortgage Calculators

These loans, called tracker mortgages, have a base benchmark interest rate from the Bank of England or the European Central Bank. Learn more about 30-year mortgage rates, and compare to a variety of other loan types. At the current average rate, you’ll pay principal and interest of $664.63 for every $100,000 you borrow. Thirty-year mortgage rates tend to track the 10-year Treasury yield, which shifts continuously alongside the economy and the forces that shape it. More recently, rates have been driven by factors like inflation, the election and geopolitical developments abroad. Thanks to rising mortgage rates, affordability has taken a toll on many home buyers.

Pros and cons of an adjustable-rate mortgage (ARM)

On top of that, the lender will also add its own fixed amount of interest to pay, which is known as the ARM margin. In many cases, ARMs come with rate caps that limit how much the rate can rise at any given time or in total. For example, if the index is 5% and the margin is 2%, the interest rate on the mortgage adjusts to 7%. However, if the index is at only 2%, the next time that the interest rate adjusts, the rate falls to 4% based on the loan’s 2% margin. ARMs may offer you flexibility, but they don’t provide you with any predictability as fixed-rate loans do.

Mortgages

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.

FAQ about adjustable-rate mortgages

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.

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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.

Is an adjustable-rate mortgage right for you?

A fixed-rate mortgage, on the other hand, has one set interest rate that doesn’t change for the life of your loan. This type of mortgage can be a more affordable means to get into a home, especially when higher rates on fixed mortgages are beginning to price some borrowers out. But is it worth the risk of unknown and potentially larger payments in the future? Here’s how to know if you should get an adjustable-rate mortgage. If interest rates in general fall, then homeowners with fixed-rate mortgages can refinance, paying off their old loan with one at a new, lower rate. 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.

Rates remain elevated Today’s mortgage rates, January 2, 2025

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.

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• Then, your rate adjusts annually for the remainder of your loan’s term.
• A 5/1 ARM means your rate is fixed for the first five years of the loan.
• An adjustable-rate mortgage (ARM) might be something to consider as you’re exploring different borrowing options.
• After that point, your rate adjusts once per year for the rest of your loan term.
• This uncertainty can make budgeting difficult and may lead to financial strain if rates increase substantially.
• If you are considering an ARM, calculate the payments for different scenarios to ensure you can still afford them up to the maximum cap.

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.

FAQs on adjustable-rate mortgages

If you don’t refinance, your mortgage payments may rise significantly once the fixed-rate period ends. If you’re buying your forever home, think carefully about whether an ARM is right for you. Interest-only ARMs are adjustable-rate mortgages in which the borrower only pays interest (no principal) for a set period. Once that interest-only period ends, the borrower starts making full principal and interest payments. ARMs come with rate caps that insulate you from possible steep year-to-year increases in monthly payments.

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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.

Borrowers faced sticker shock when their ARMs adjusted, and their payments skyrocketed. Since then, government regulations and legislation have increased the oversight of ARMs. The partial amortization schedule below shows how you pay the adjustable rate mortgage rates same monthly payment with a fixed-rate mortgage, but the amount that goes toward your principal and interest payment can change. In this example, the mortgage term is 30 years, the principal is $100,000, and the interest rate is 6%.

• The foreclosure wave that followed prompted the federal government to heavily restrict this type of ARM, and it’s rare to find one today.
• This can make ARMs attractive for buyers who plan to sell or refinance before the adjustable period begins.
• 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.
• Let’s say you took out a 30-year 5/1 ARM for $350,000 with an introductory rate of 6.65 percent (the average rate as of this writing).
• An interest-only mortgage is when you pay only the interest as your monthly payments for several years.
• The main benefit of an ARM is the lower initial interest rate, which can result in lower monthly payments during the initial period.

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.

Our mission is to provide readers with accurate and unbiased information, and we have editorial standards in place to ensure that happens. Our editors and reporters thoroughly fact-check editorial content to ensure the information you’re reading is accurate. We maintain a firewall between our advertisers and our editorial team. Our editorial team does not receive direct compensation from our advertisers. Adjustable-rate mortgages, on the other hand, have fluctuating interest rates.

How much does 1 point lower your interest rate?

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.

Cons of an ARM

• Our editors and reporters thoroughly fact-check editorial content to ensure the information you’re reading is accurate.
• If rates decrease later, your monthly mortgage payment could go down.
• 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.
• Yes, their favorable introductory rates are appealing, and an ARM could help you to get a larger loan for a home.
• Fixed-rate mortgages offer interest rate stability over the life of the loan, providing predictable monthly payments and long-term financial planning security.

A 5/5 ARM is a mortgage with an adjustable rate that adjusts every 5 years. During the initial period of 5 years, the interest rate will remain the same. After that, it will remain the same for another 5 years and then adjust again, and so on until the end of the mortgage term. A major advantage of an ARM is that it generally has cheaper monthly payments compared to a fixed-rate mortgage, at least initially.

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.

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.

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.

• 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.
• Learn more about how fixed-rate mortgages compare to adjustable-rate mortgages, including the pros and cons of each.
• Still, borrowers considering an ARM should always plan for the worst-case scenario.
• If you’re in the military and find yourself relocating every 4 to 5 years, for example, the lower initial rate and payments on an ARM could be a better option than a fixed-rate mortgage.
• A month ago, the average rate on a 30-year fixed refinance was lower at 6.75 percent.
• 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.
• The average 30-year fixed-refinance rate is 7.01 percent, down 4 basis points over the last week.

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.

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.

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.

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.

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.

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.

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.