Definition
An ARM starts with a lower rate than fixed mortgages, but that rate adjusts periodically (usually annually) based on market conditions. After the fixed period (3, 5, 7, or 10 years), your rate and payment can increase significantly. It's cheaper initially but riskier long-term.
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ARMs are structured with an initial fixed period (e.g., 3, 5, 7, or 10 years), followed by periodic rate adjustments, usually annually or semi-annually. These mortgages include caps that limit how much the rate can increase per adjustment period and over the loan's lifetime. They appeal to borrowers planning to sell or refinance before the adjustable period begins.
Pro Tip
ARMs save thousands in interest if you're confident you'll move or refinance before the adjustable period begins; evaluate your actual plans carefully.
Example
A borrower obtains a 5/1 ARM at 5.5% for the first 5 years. After the initial period, the rate adjusts annually. If they plan to sell in 4 years, they benefit from the lower initial rate without rate adjustment risk.