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

It’s possible for your ARM rate to go down if interest rates fall and then your rate adjusts. ARM rates are much more likely to increase when they adjust than to decrease. An adjustable-rate mortgage is a great tool for many home buyers, but it also comes with serious risks that borrowers need to be prepared for. It can be, especially if they plan to sell or refinance before the initial fixed-rate period ends. Rate caps limit how much the interest rate can increase at each adjustment period and over the life of the loan.

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

In most cases, the rate will stay the same for a set amount of time based on the lender and type of ARM you choose. This could mean the rate is the same for the first month or up to five years. For example, if you get a 5/1 ARM, your rate will remain fixed for the first five years and then will become variable for the rest of the term. A hybrid ARM is an adjustable rate mortgage that remains fixed for an initial period and then adjusts regularly thereafter. For example, a hybrid ARM may remain fixed for the first 5 years, and then adjust every year after that. 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.

Get answers to your adjustable-rate mortgage questions

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.

Adjustable-Rate Mortgage: What an ARM Is and How It Works

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.

What are ARM rate caps?

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.

Is an Adjustable-Rate Mortgage Right For You?

The initial interest rate on an adjustable-rate mortgage is sometimes called a “teaser” rate, and ARMs themselves are sometimes referred to as “teaser” loans. There are different types of ARMs to choose from, and they have pros and cons. ARMs offer flexibility, allowing homeowners to benefit from lower initial rates and potentially lower payments if market rates decrease. However, this comes with the risk of rising payments if rates increase. Our goal is to give you the best advice to help you make smart personal finance decisions. We follow strict guidelines to ensure that our editorial content is not influenced by advertisers.

Key features of adjustable-rate mortgages

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.

year mortgage rate declines, -0.01%

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.

Interest-Only (I-O) ARM

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.

Harder To Budget For

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.

What are today’s mortgage rates?

Then, the rate adjusts every year after that, which is what the second number indicates. One of the major cons of ARMs is that the interest rate will change. This means that if market conditions lead to a rate hike, you’ll end up spending more on your monthly mortgage payment. ARMs are great for people who want to finance a short-term purchase, such as a starter home. Or you may want to borrow using an ARM to finance the purchase of a home that you intend to flip.

ARM vs. Fixed-Rate Mortgage: Which One Is Right For You?

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 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.

• With this type of loan, the interest rate will be fixed at the beginning and then begin to float at a predetermined time.
• 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.
• We do not include the universe of companies or financial offers that may be available to you.
• This can lead to lower payments in the short term but introduces the risk of rising payments in the future.
• 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.
• Since then, government regulations and legislation have increased the oversight of ARMs.

This can make it more difficult to budget mortgage payments in a long-term financial plan. ARMs have a fixed period of time during which the initial interest rate remains constant. After that, the interest rate adjusts at specific regular intervals. The period after which the interest rate can change can vary significantly—from about one month to 10 years. Shorter adjustment periods generally carry lower initial interest rates.

• This means that there are limits on the highest possible rate a borrower must pay.
• An ARM can also be helpful in a rising-rate market where high fixed rates are pricing buyers out of the homes they wanted.
• 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.
• It’s also important to understand how adjustable mortgage rates work when it comes time for your rate to adjust.
• 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.
• 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).

Why ARMs are popular right now

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.

Types of ARMs

If you persist with paying off little, then you’ll find your debt keeps growing, perhaps to unmanageable levels. This means that there are limits on the highest possible rate a borrower must pay. Keep in mind, though, that your credit score plays an important role in determining how much you’ll pay. Mortgage rates moved in different directions compared to last week, according to Bankrate data.

FAQs on adjustable-rate mortgages

• Weight the pros and cons of a fixed vs. adjustable-rate mortgage, including their initial monthly payment amounts and their long-term interest.
• An adjustable-rate mortgage (ARM) might be something to consider as you’re exploring different borrowing options.
• The fact that payments remain the same provides predictability, which makes budgeting easier.
• During the initial period of 5 years, the interest rate will remain the same.
• Fixed-rate mortgages offer stability and predictability, while ARMs provide lower initial payments and potential savings.
• This uncertainty can make budgeting difficult and may lead to financial strain if rates increase substantially.
• 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.

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.

Fixed-rate mortgages and adjustable-rate mortgages (ARMs) are the two types of mortgages that have different interest rate structures. 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. Learn more about how fixed-rate mortgages compare to adjustable-rate mortgages, including the pros and cons of each. ARMs tend to be more popular with younger, higher-income households with bigger mortgages, according to the Federal Reserve Bank of St. Louis. Nearly 19 percent of households in the top income decile have ARMs compared with just 6.5 percent in the bottom income decile. The most common initial fixed-rate periods are three, five, seven and 10 years.

The offers that appear on this site are from companies that compensate us. But this compensation does not influence the information we publish, or the reviews that you see on this site. We do not include the universe of companies or financial offers that may be available to you. Some adjustable-rate mortgage loans come with an early payoff penalty.

• When you’ve decided which type of mortgage is best for you, reach out to a lender to get started right away.
• Since ARMs can have lower payments at the start, they can offer more flexibility — at least toward the beginning of the mortgage.
• Using the 5/1 ARM example, after your fixed rate expires, your interest rate could adjust up or down once each year.
• This means that the monthly payments for principal and interest will not change, providing stability and predictability for homeowners.
• With an I-O home loan, you’ll have smaller monthly payments that increase over time as you eventually start to pay down the principal balance.
• 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.
• Here’s how to know if you should get an adjustable-rate mortgage.
• Borrowers faced sticker shock when their ARMs adjusted, and their payments skyrocketed.

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.

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

If you keep the same loan with the same lender, your mortgage payment won’t change. An ARM, sometimes called a variable-rate mortgage, is a mortgage with an interest rate that changes or fluctuates during your loan term. Other loans typically have a fixed rate, where the interest rate doesn’t change over the life of the loan.

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.

This allows them to still afford the home they want without having to compromise due to higher rates. With a rate cap structure of 2/2/5, your rate could increase up to 5% at its first adjustment; as high as 7% at its second adjustment; and no higher than 8% over the entire life of the loan. The first number is how long the interest rate is fixed and the second number is how frequently that rate changes after the initial period. 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. Based on the terms you agreed to with your mortgage lender, your payment could change from one month to the next, or you might not see a change for many months or even years.

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.

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.

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 what is 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.

• ARMs have a fixed period of time during which the initial interest rate remains constant.
• 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.
• However, ARM loans often grow in popularity when rates are rising.
• The lender then applies a margin on top of that (it’s the lender’s profits).
• Just ensure your lender doesn’t charge you a prepayment fee if you do.

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.

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.

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.