Adjustable-rate mortgages have a reputation that doesn't always match how they work. For the right buyer, an ARM can be a smart, flexible way to finance a home.
When most people picture a mortgage, they picture a fixed rate that stays the same for the life of the loan. That's a great fit for many buyers. But it isn't the only option, and depending on your plans, an adjustable-rate mortgage might be worth a closer look. Here's how ARMs work, in plain terms.
How an ARM works
An adjustable-rate mortgage has two phases. First comes an initial fixed period, often several years, when your interest rate stays the same. After that, the rate can adjust periodically, up or down, based on a market index plus a set margin spelled out in your loan documents.
An ARM may start with a lower initial rate than a comparable fixed-rate loan. That's the main reason buyers consider one.
Decoding the name: 5/6, 7/6, 10/6
ARM names look like a code, but they're simple once you know the formula.
- The first number is how many years your rate stays fixed.
- The second number tells you how often the rate can adjust after that. A "6" means every six months.
So a 7/6 ARM has a rate that's fixed for seven years, then can adjust every six months. Common options include 5/6, 7/6 and 10/6, and availability varies by lender and loan program.
The right mortgage isn't about the lowest number today. It's about the strategy that fits your life.
Rate caps: the built-in limits
Rate caps are what make an ARM something you can plan around. They limit how much your rate can change:
- Initial adjustment cap: how much the rate can change at the first adjustment.
- Periodic cap: how much it can change at each adjustment after that.
- Lifetime cap: the most the rate can ever increase over the life of the loan.
Your caps are spelled out in your loan disclosures, and a loan officer can walk you through exactly what they mean for your payment.
Who an ARM can be a good fit for
An ARM can work well when your plans line up with the fixed period. For example, buyers who:
- Expect to sell or move before the fixed period ends
- Are buying a starter home and plan to upgrade in a few years
- Want a lower starting rate and have a clear plan for the years after the fixed period
- Expect their income to grow and are comfortable budgeting for a possible adjustment
It's worth being honest with yourself about one thing: plans can change. A good ARM strategy accounts for what you'd do if you stay longer than expected, rather than counting on a future refinance.
Questions to ask your loan officer
- Which ARM options are available for my loan program?
- How long is the fixed period, and how often can the rate adjust after that?
- What are the initial, periodic and lifetime caps?
- What index is the rate tied to, and what is the margin?
- Can you show me a side-by-side comparison with a fixed-rate loan for my situation?
A loan officer can lay out ARM and fixed-rate scenarios next to each other so you can see how each fits your timeline and budget.
Good to Know
This article is for general educational purposes only and is not an offer to lend or a commitment to any rate or terms. With an adjustable-rate mortgage, the interest rate and payment can change after the initial fixed period. ARM availability, terms, indexes, margins and caps vary by lender and loan program. All loans are subject to credit approval, underwriting and program guidelines. Talk with a licensed loan officer about your specific situation.