What Is An Adjustable-Rate Mortgage?

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.

How Adjustable-Rate Mortgages (ARMs) Work

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.

Pros of an Adjustable-Rate Mortgage

Bankrate follows a stricteditorial policy, so you can trust that our content is honest and accurate. The content created by our editorial staff is objective, factual, and not influenced by our advertisers. An adjustable-rate mortgage (ARM) is a type of home loan that offers a low fixed rate for the first few years, after which your interest rate and payment can move up or down with the market. 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. The longer your I-O period, the larger your monthly payments will be after the I-O period ends. With a fixed-rate loan, you’ll pay one set amount every month for the duration of your loan term, like 15, 20 or 30 years.

Is a Fixed-Rate Mortgage or ARM Right for You?

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.

Adjustable-rate mortgage FAQ

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.

Mortgages

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.

• 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.
• The content created by our editorial staff is objective, factual, and not influenced by our advertisers.
• 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.
• 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.
• Yes, if your ARM loan comes with a “conversion option.” Lenders may offer this choice with conditions and potentially an extra cost, allowing you to convert your ARM loan to a fixed-rate loan.
• 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.
• For these averages, APRs and rates are based on no existing relationship or automatic payments.

How much does 1 point lower your interest rate?

An adjustable-rate mortgage, or ARM, is a home loan that has an initial, low fixed-rate period of several years. After that, for the remainder of the loan term, the interest rate resets at regular intervals. When you get a mortgage, you can choose a fixed interest rate or one that changes. Typically, ARM loan rates start lower than their fixed-rate counterparts, then adjust upwards once the introductory period is over. Fixed-rate mortgages make up almost the entire mortgage market when rates are low.

CFPB Report Finds Significant Drop in Annual Mortgage Applications and Originations in 2023

Choosing between fixed and adjustable-rate mortgages depends on your financial goals, risk tolerance, and market conditions. Fixed-rate mortgages offer stability and predictability, while ARMs provide lower initial payments and potential savings. Consulting with a financial advisor or mortgage specialist can provide personalized guidance tailored to your specific financial situation and goals.

What Is An Adjustable-Rate Mortgage?

One drawback is that fixed-rate mortgages often have higher initial interest rates compared to adjustable-rate mortgages. Additionally, if market interest rates decline, homeowners with fixed-rate mortgages will not benefit from the lower rates unless they refinance their loans. Bankrate follows a strict editorial policy, so you can trust that we’re putting your interests first.

ARM caps in action

• 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.
• Traditional lenders offer fixed-rate mortgages for a variety of terms, the most common of which are 30, 20, and 15 years.
• More recently, rates have been driven by factors like inflation, the election and geopolitical developments abroad.
• This can make it hard to budget and plan for and could strain your finances.
• Additionally, if market interest rates decline, homeowners with fixed-rate mortgages will not benefit from the lower rates unless they refinance their loans.

The graphic below shows how rate caps would prevent your rate from doubling if your 3.5% start rate was ready to adjust in June 2023 on a $350,000 loan amount. Fixed-rate mortgages offer interest rate stability over the life of the loan, providing predictable monthly payments and long-term financial planning security. So with a 5/1 ARM, you have a 5-year intro period and then 25 years during which your rate and payment can adjust each year. Note that modern adjustable-rate mortgages come with interest rate caps that limit how high your rate can go, so the cost can’t just increase every year for 25 years. Regardless of the loan type you select, choosing carefully will help you avoid costly mistakes. Weight the pros and cons of a fixed vs. adjustable-rate mortgage, including their initial monthly payment amounts and their long-term interest.

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 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%.

Is an Adjustable-Rate Mortgage Right For You?

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.

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.

• These adjustments are based on a market index—the Secured Overnight Financing Rate (SOFR) being the most common for adjustable-rate products—that your lender uses to set and follow rates.
• Shorter adjustment periods generally carry lower initial interest rates.
• This allows you to pay lower monthly payments until you decide to sell again.
• However, the deterioration of the thrift industry later that decade prompted authorities to reconsider their initial resistance and become more flexible.
• Some of the most common terms are 5/1, 7/1, and 10/1 ARMs, but many lenders offer shorter or longer intro periods.
• But payments will balloon later on, and when this happens you will still have the full loan balance to pay off.

How does an adjustable-rate mortgage work?

Fixed and adjustable-rate mortgages choosing depends on your financial goals and risk tolerance. Fixed-rate mortgages offer stable interest rates and predictable monthly payments, ideal for long-term planning and security. Adjustable-rate mortgages (ARMs), on the other hand, start with lower initial interest rates, which can adjust periodically based on market conditions.

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.

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.

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.

When you get a mortgage, you’ll pay interest on the money you borrow. Your interest rate can be either fixed or adjustable — sometimes called variable. This booklet helps you understand important loan documents your lender gives you when you apply for an adjustable-rate mortgage (ARM). With nearly two decades in journalism, Dori Zinn has covered loans and other personal finance topics for the better part of her career. She loves helping people learn about money, whether that’s preparing for retirement, saving for college, crafting a budget or starting to invest. Her work has been featured in the New York Times, Wall Street Journal, CNN, Yahoo, TIME, AP, CNET, New York Post and more.

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.

But payments will balloon later on, and when this happens you will still have the full loan balance to pay off. Keep in mind that adjustable mortgage rate don’t always increase. If the index rate to which your loan is tied has fallen by the time your loan adjusts, your rate and payment also have to potential to go down. The initial period of an ARM where the interest rate arm rates today remains the same typically ranges from one year to seven years. An ARM may make good financial sense if you only plan to live in your house for that amount of time or plan to pay off your mortgage early, before interest rates can rise. While there are rate caps in place to protect you, that doesn’t mean your rate and payment can’t increase significantly over time.

Borrowers with fixed-rate loans know what their payments will be throughout the life of the loan because the interest rate never changes. But because the rate changes with ARMs, you’ll have to keep juggling your budget with every rate change. In most cases, the first number indicates the length of time that the fixed rate is applied to the loan, while the second refers to the duration or adjustment frequency of the variable rate. The average rate for a jumbo mortgage is 7.02 percent, an increase of 7 basis points over the last week. This time a month ago, the average rate on a jumbo mortgage was lower at 6.87 percent. First, if you intend to live in the home only a short period of time, you may want to take advantage of the lower initial interest rates ARMs provide.