An Adjustable Rate Mortgage (ARM) is a mortgage loan with an interest rate that changes (adjusts) over time. The rate is tied to a specific index in the market and adjusts within defined limits (CAPs) set in the loan program. Typically, your interest rate is fixed for an initial period of time (5 years is pretty common), after which your interest rate may adjust on the anniversary of your loan. The frequency and the amount of change is limited by the CAPs on the loan program.
Just because you have an ARM does not mean that your interest rate will not automatically increase. The rate will only increase if the index that your loan is tied to has increased at the time your interest rate is eligible to adjust. Your interest rate is also eligible to decrease, should the index have dropped over the same period of time.
Although your interest rate is more volatile with an ARM, ARMs can be advantageous for certain borrowers. If you know that you will not be in the home “long term” or if you plan to pay off your mortgage sooner, having an adjustable rate mortgage may make more sense.
Typically speaking, most ARMs have lower interest rates initially than their fixed counterparts, though not always.