Definition
Imagine a mortgage that acts like an introductory rate at a credit card—you start with a low interest rate, but after a few years, your rate adjusts and payments can jump significantly. This type of loan is riskier because of that payment shock.
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ARMs have initial low rate (3-5 years) then adjust annually. Rates tied to index. Initial savings attractive. Payment shock possible after fixed period. Caps limit rate increases. Higher risk than fixed-rate. Less common post-2008 crisis. Refinancing common before rate adjustment. Strategic use by knowledgeable borrowers. Professional analysis critical. Index selection important. Consumer be aware of reset terms. Risk management essential.
Pro Tip
If you choose an ARM, understand exactly when the rate resets and plan to refinance before rates increase substantially.
Example
5/1 ARM at 3% reset to 5% after 5 years increasing payment $200+.