Adjustable Rate Mortgages: Who Should Use Them and How They Work

Choosing a mortgage program is about more than qualifying – it’s about finding the program that works for your current and future financial goals. Using an adjustable rate mortgage, also known as an ARM, allows you to build flexibility into your loan so you can adapt to the market in a favorable way.

Key Takeaways About Adjustable Rate Mortgages

Need quick answers in your journey to finding the perfect home loan? Here’s a quick breakdown of the key facts you need about ARMs.


  • Adjustable rate mortgages offer lower initial rates for a set amount of time at the beginning of the loan
  • Changes to the rate happen at regular intervals, set up front during your loan process
  • ARMs are a great choice for buyers who know they won’t be in a home for an extended period of time

What is an Adjustable Rate Mortgage?

Adjustable rate mortgages, also referred to as ARMs by many in the loan and real estate industry, is a mortgage loan that offers a changing interest rate. While most loan options lock your rate at the beginning of the process and keep it the same throughout the life of the loan, an ARM allows you to take advantage of changing interest rates by adjusting your rate as the interest rate changes based on the financial index.

ARMs generally start with a lower rate for the beginning of the loan. This time can change depending on the lender you use, but usually stays for anywhere between three and ten years. This introductory period allows you to have predictable payments for the first few years of the loan.

When your adjustment period ends, the interest rate on the loan will begin changing. The interest rate generally changes once a year but can be more or less frequent depending on the exact specifications of the loan program you choose. We recommend speaking with an experienced mortgage broker to make sure you’re getting a loan package that works for your financial goals.

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    Who Should Use an ARM?

    Adjustable-rate mortgages are best suited for specific financial situations, offering initial savings through lower interest rates during the first years of the loan. Ideal candidates for ARMs are:

    • Short-term Homeowners: If you plan on living in your new home for only a few years, an ARM can provide lower monthly payments initially, allowing you to benefit from reduced rates before moving on.
    • Future Refinancers: Those anticipating a refinancing of their mortgage to capitalize on expected lower interest rates will find ARMs appealing. This strategy relies on timing the market to lock in savings before rate adjustments begin.
    • Career Starters: Individuals at the beginning of their careers, who anticipate growth in their income, might prefer an ARM. The lower initial payments can ease budget strain, giving room for financial growth and stability as income increases.
    • Financial Strategists: Borrowers who foresee significant changes in their financial status, like receiving an inheritance, can leverage the initial lower payments of an ARM while planning to pay off the loan early before higher rates apply.

    Moreover, ARMs often come with rate caps that limit the extent of interest rate increases, offering some predictability against payment surges. However, potential borrowers should be aware of risks such as payment shock if rates increase significantly after the initial fixed-rate period. Careful consideration and planning are essential to determine if an ARM is the right choice based on personal financial stability and housing market conditions.


      Types of ARM Loans

      While the title implies one type of loan, adjustable-rate mortgages actually encompass an entire category of loan programs that offer rate flexibility. Determining which of the below loan programs is best for you can be simple when you use a mortgage broker. Let’s review the different loan types you might be able to qualify for within the adjustable rate mortgage category.

          Understanding how to read this mortgage shorthand may seem tricky, but the system is fairly simple. The first number in the fraction (the numerator) is how long your mortgage rate will be static during the introductory period of the loan. The lower number (or the denominator) will show how often your rate will change after the introductory period. This is usually represented as one or six, meaning once a year or every six months.

          Interest-only ARMs: These ARMs allow borrowers to pay only the interest on the loan for a specified period at the beginning of the loan term, which can range from several months to several years. This period allows for significantly lower payments initially but does not build equity unless the property’s value increases.

          Payment-option ARMs: These provide multiple payment methods including minimum payments that may not cover the full interest and could lead to negative amortization, where the loan balance grows rather than shrinks. After this period, payments increase as the borrower begins to pay off principal as well as interest.

          Commons Loan Programs Names In The ARM Category

          • 3/1 and 3/6 ARMs: Fixed for three years, then adjusted annually or every six months.
          • 5/1 and 5/6 ARMs: Fixed for five years, then adjusted annually or every six months.
          • 7/1 and 7/6 ARMs: Fixed for seven years, then adjusted annually or every six months.
          • 10/1 and 10/6 ARMs: Fixed for ten years, then adjusted annually or every six months.

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          Fixed Rate Loans vs ARMS

          When considering a mortgage, understanding the differences between fixed-rate and adjustable-rate mortgages is crucial for making an informed decision. For those trying to decide between the two, here are some key things you should consider when weighing a fixed-rate loan against an adjustable-rate loan.

          Fixed-Rate Mortgages: These mortgages maintain the same interest rate throughout the loan, providing a consistent monthly payment that does not change. This predictability makes budgeting easier and shields borrowers from rising interest rates. However, if rates fall, refinancing is necessary to benefit from lower rates, which can involve additional costs.

          Adjustable-Rate Mortgages: ARMs offer an initial period where the interest rate is fixed, usually at a lower rate compared to fixed-rate mortgages. After this period, the rate adjusts at predetermined intervals based on a specific index plus a margin. This can make ARMs initially more affordable, but they carry the risk of increasing payments if interest rates rise.

          Key Differences:

          • Interest Rate Changes: ARMs can change after the initial fixed period, which can lead to lower costs if rates decrease or higher costs if rates increase. Fixed-rate mortgages stay the same, providing stability.
          • Rate Caps: ARMs typically include caps that limit how much the interest rate can change during adjustment periods and over the life of the loan, which provides some protection against drastic rate increases.
          • Initial Costs: ARMs often have lower initial rates, making them attractive to those who plan to move or refinance before the rate adjusts.

          Who Should Choose What?:

          • ARMs: Suitable for those who anticipate a short stay in their home, expect future income increases, or are entering a high-interest rate market where rates are expected to drop.
          • Fixed-Rate Mortgages: Best for individuals planning to stay in their home long-term, have a fixed budget, or are entering a market with historically low rates.

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              What are Rate Caps for ARMs?

              Adjustable-rate mortgages come with built-in protections known as rate caps, which are essential for managing the risks associated with variable interest rates. Understanding these caps can help you decide if an ARM is a suitable choice for your mortgage needs. Here’s a concise overview based on current, authoritative financial resources:

              Types of Rate Caps:

              Initial Adjustment Cap: This cap limits how much the interest rate can increase or decrease at the first adjustment after the fixed-rate period ends. Commonly, this cap is set at 2% or 5%, ensuring that the rate does not rise more than a predetermined percentage above the initial rate.

              Subsequent Adjustment Cap (Periodic Cap): This cap controls the amount by which the interest rate can change during each adjustment period after the first. This cap is often set at 2%, which helps prevent dramatic increases from one adjustment period to the next.

              Lifetime Cap: This is the maximum amount that the interest rate can increase over the life of the loan, relative to the initial rate. A common lifetime cap is around 5%, although this can vary depending on the lender and the specific loan terms​.

              Function of Rate Caps: Rate caps are designed to offer borrowers protection from extreme fluctuations in interest rates. By limiting how much and how often rates can increase, these caps help to ensure that your payments remain within a manageable range, even if market conditions change significantly. They provide a safeguard against payment shock, which can occur if rates increase sharply over a short period.

              Quotes Are Cool, But Real Rates Are Better

              The experienced team at Abo Capital will run your numbers and get you an accurate rate estimate to help you make an actionable mortgage plan. With a deeper understanding of all your numbers, we can guide you to the best mortgage choice for your short- and long-term goals.

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              FAQs About Adjustable Rate Mortgages

              Is an adjustable-rate mortgage a good idea?

              An adjustable-rate mortgage can be a good choice if you plan to sell your home or refinance before the rate adjusts, or if you expect a significant increase in your future income. ARMs often offer lower initial interest rates than fixed-rate mortgages, providing potentially lower payments initially. However, they carry the risk of higher payments later if interest rates increase.

              Which ARM type should I use?

              The choice of ARM type largely depends on your financial plans and how long you expect to stay in your home. Common ARM types include 3/1, 5/1, 7/1, and 10/1, where the first number represents the years the rate remains fixed, and the second number represents how often the rate adjusts after the initial period. Choose a shorter fixed period if you plan to move soon, or a longer one if you prefer more stability before potential rate changes. 

              Can I pay off my ARM early?

              Yes, you can pay off your ARM early. Most ARMs allow you to make extra payments toward the principal without a prepayment penalty, effectively reducing the total interest you pay over the life of the loan. It’s important to review your specific mortgage agreement to understand any terms or potential fees associated with early payoff.