What is an adjustable-rate mortgage?
An adjustable-rate mortgage (ARM) is a home loan with an interest rate that is generally fixed for an introductory period and then adjusts at scheduled intervals. During the initial fixed-rate period, the interest rate remains unchanged, although the total monthly mortgage payment may still change if property taxes, homeowners insurance or other escrowed expenses change.
Common introductory fixed-rate periods include five, seven and ten years, although available terms vary by lender and loan program. Some ARMs offer a lower interest rate than comparable fixed-rate mortgages, but that is not always the case.
Unlike a fixed-rate mortgage, which maintains the same interest rate throughout the entire loan term, an ARM introduces the possibility of future interest rate and monthly principal-and-interest payment changes.
How does an adjustable-rate mortgage work?
An ARM generally has two phases: an initial fixed-rate period and an adjustable period. After the introductory fixed period ends, the mortgage interest rate can increase or decrease at intervals specified in the loan documents.
The adjusted interest rate is generally based on two components:
- Index rate: A published benchmark that changes with market conditions. Some ARMs use a benchmark based on the Secured Overnight Financing Rate (SOFR) or a U.S. Treasury index.
- Margin: A percentage specified in the loan agreement that is added to the index rate. The margin generally stays the same throughout the loan term.
At each scheduled adjustment, the lender calculates the new interest rate using the applicable index and margin, subject to the loan’s rate caps, floors and rounding rules. Your monthly principal-and-interest payment may then be recalculated under the loan’s terms.
An ARM’s interest rate affects how much interest you pay and how your monthly principal-and-interest payment is calculated. Your principal balance is the amount you still owe on the mortgage, excluding interest. On a standard, fully amortizing ARM, each scheduled payment generally reduces that balance over time. When the interest rate adjusts, the lender may recalculate your monthly payment based on the remaining principal balance, remaining loan term and new interest rate, subject to the loan’s terms.
Your loan disclosures explain when adjustments can occur, how the new interest rate is calculated and what limits apply. The Consumer Financial Protection Bureau’s Consumer Handbook on Adjustable-Rate Mortgages provides additional guidance.
Common ARM structures and loan terms
ARM names typically identify the length of the introductory fixed-rate period and how frequently the rate may adjust afterward.
| ARM structure | Initial fixed-rate period | Adjustment frequency afterward |
|---|---|---|
| 5/6 ARM | 5 years | Every 6 months |
| 7/6 ARM | 7 years | Every 6 months |
| 10/6 ARM | 10 years | Every 6 months |
For example, a 5/6 ARM generally has a fixed interest rate for five years, followed by potential adjustments every six months.
These loans are often called hybrid ARMs because they combine an initial fixed-rate period with subsequent rate adjustments.
A shorter introductory period may be worth considering if you expect to move sooner, while a longer period provides more time before the first possible adjustment. However, initial pricing and available terms vary. Compare actual loan estimates rather than assuming one ARM structure will always be cheaper than another.
CrossCountry Mortgage offers adjustable-rate mortgage options. A loan officer can explain the structures currently available for your situation.
ARM indexes, margins and adjustment periods
Three terms are especially important when reviewing an ARM offer:
Index rate: The benchmark used to calculate future rate adjustments. Its value may rise or fall over time.
Margin: The amount added to the index rate to determine the calculated interest rate. Your loan documents specify the margin.
Adjustment period: How often the rate can change after the introductory fixed period. Depending on the product, adjustments may occur every six months, annually or at another specified interval.
Your loan may also include a rate floor, which limits how far the rate can fall, and a lookback period, which determines the date used to select the index value for an adjustment. The exact terms depend on the loan program and agreement.
Rate caps and how they protect you
Interest rate caps limit how much an ARM’s rate can change at certain points. They reduce exposure to abrupt rate increases but do not eliminate the possibility of higher monthly payments.
- Initial adjustment cap: Limits how much the interest rate can increase at the first adjustment after the fixed-rate period ends
- Subsequent adjustment cap: Limits changes at later scheduled adjustments
- Lifetime cap: Limits how much the interest rate can increase over the entire loan term, generally measured relative to the initial rate
For example, a cap structure described as 2/1/5 generally means the rate cannot increase by more than two percentage points at the first adjustment, one percentage point at each later adjustment, or five percentage points above the initial rate over the loan’s lifetime. Actual cap structures vary by product, and some loan terms also limit downward adjustments.
Even with caps, your monthly principal-and-interest payment may rise substantially over time. Ask your loan officer to explain the maximum possible interest rate and payment under your specific loan terms. You can also explore scenarios using an adjustable-rate mortgage calculator.
Adjustable-rate vs. fixed-rate mortgages
The primary tradeoff is between long-term stability and the possibility of a lower initial interest rate.
| Feature | Fixed-rate mortgage | Adjustable-rate mortgage |
|---|---|---|
| Interest rate | Remains fixed for the entire loan term | Initially fixed, then may adjust periodically |
| Principal-and-interest payment | Generally stays the same | May increase or decrease after adjustments |
| Initial rate | Depends on current mortgage rates and loan terms | May be lower than a comparable fixed rate |
| Future rate risk | No scheduled interest-rate adjustments | Subject to index changes, caps and other loan terms |
| Best fit | Borrowers prioritizing long-term stability | Borrowers comfortable evaluating future rate risk |
Neither option is always less expensive. The better choice depends on actual interest rates, fees, how long you keep the loan and what happens after the ARM’s fixed period ends. Remember that taxes, homeowners insurance and other housing expenses can change under either loan type.
A CrossCountry Mortgage loan officer can help you compare adjustable-rate and fixed-rate mortgages using current loan terms.
Pros of adjustable-rate mortgages
An ARM may offer several advantages, depending on the loan terms and your circumstances:
- Potentially lower initial rate: Some ARMs offer a lower starting interest rate and principal-and-interest payment than comparable fixed-rate loans.
- Potential savings during the fixed period: If the initial ARM rate is lower, you may pay less interest or have lower monthly payments during that period. Compare fees and total borrowing costs, too.
- Flexibility for shorter ownership plans: An ARM may appeal to buyers who expect to move before the fixed period ends, although plans can change.
- Potential benefit if the index declines: After the initial period, the interest rate may decrease when the applicable benchmark rate falls, subject to the loan’s floors, caps and other terms.
Cons and risks of adjustable-rate mortgages
ARMs also carry risks that deserve careful consideration:
- Higher future payments: If the adjusted rate rises, the monthly principal-and-interest payment can increase, potentially by a meaningful amount.
- Budgeting uncertainty: The payment you make after the initial fixed period may differ from the monthly payment at closing.
- Changes to your plans: You may remain in the home longer than expected or be unable to sell when you planned.
- Refinancing uncertainty: Refinancing is not guaranteed. Future mortgage rates, home values, income, credit and underwriting requirements may affect your eligibility, and refinancing typically involves costs.
- More complex terms: Indexes, margins, rate caps, floors and adjustment schedules require closer review than a traditional fixed-rate loan.
Before choosing an ARM, review the maximum possible rate and payment disclosed for the loan and consider whether your budget could accommodate higher monthly payments.
Who might consider an ARM?
An ARM may be worth exploring if you:
- Expect to move within a relatively short period: You may prefer an initial fixed period that aligns with your expected ownership timeline, while allowing for the possibility that your plans change.
- Want to compare initial monthly payment options: An ARM may offer a lower initial payment, depending on current pricing.
- Have room in your budget for potential increases: Financial flexibility can help you manage payment changes after the initial period.
- Are considering refinancing later: You can evaluate an ARM alongside your longer-term plans, but you should not depend on future refinancing being available or affordable.
A fixed-rate mortgage may be preferable if you value long-term payment predictability or would have difficulty handling higher monthly payments. A licensed CrossCountry Mortgage loan officer can help you compare the available loan options.
ARM loans, FHA loans and other loan types
Adjustable-rate features are available through several mortgage programs, subject to program and lender requirements.
Conventional ARMs: Some conventional loans, including eligible conforming loans, offer adjustable rates. Conforming loans generally follow applicable Fannie Mae or Freddie Mac requirements and loan limits. Limits vary by year, property type and location.
FHA ARMs: Certain Federal Housing Administration (FHA) loans offer adjustable-rate structures. Their adjustment schedules and rate caps may differ from conventional ARMs. Review current HUD program requirements for details.
VA ARMs: Adjustable-rate options may be available to eligible borrowers through Veterans Affairs (VA) loans, subject to applicable program rules and lender offerings.
Jumbo and other nonconforming ARMs: Some lenders offer ARMs for loans outside conforming guidelines. Eligibility, pricing, down payment requirements and loan terms vary.
CrossCountry Mortgage offers conventional loans, FHA loans, adjustable-rate mortgages (ARMs) and other mortgage options. A licensed loan officer can help you explore available programs and determine which options may fit your financial goals.
How to evaluate if an ARM fits your plans
Consider your timeline. Estimate how long you may own the home, but account for the possibility of staying longer than expected.
Compare complete loan offers. Look beyond the introductory rate. Review the annual percentage rate (APR), lender fees, mortgage points, initial payments, adjustment rules and potential future payments.
Stress-test your budget. Use a mortgage payment calculator and your loan disclosures to understand how a higher interest rate could affect affordability. Consider property taxes, homeowners insurance, other debts and emergency savings as well.
Make a backup plan. Consider what you would do if rates rose, home values declined or refinancing was unavailable when the fixed period ends.
Steps to apply for an adjustable-rate mortgage
Applying for an ARM is similar to applying for other mortgage loans, with additional attention to the adjustment terms.
Step 1: Explore pre-approval. A loan officer can review your income, assets, debts, credit and other information to help determine which programs you may qualify for. Credit score and debt-to-income requirements vary by program, lender and borrower circumstances. Learn more about mortgage pre-approval.
Step 2: Gather documentation. Depending on your situation and the loan program, you may be asked for recent pay stubs, W-2s or tax returns, bank statements, identification and information about existing debts or real estate.
Step 3: Review the ARM terms. Compare the initial fixed period, index rate, margin, rate caps, rate floor, adjustment frequency and potential future payments. Ask about any additional features and whether they are available on the loan you are considering.
Step 4: Complete underwriting and closing. Your lender will explain applicable rate-lock options, review required documentation and guide you through the remaining steps.
Ready to compare ARM and fixed-rate options? Contact CrossCountry Mortgage to discuss your goals or get pre-approved.
Frequently asked questions about adjustable-rate mortgages
-
Potentially. You may be able to refinance an ARM into a fixed-rate mortgage if you qualify under the requirements in effect when you apply. Eligibility depends on factors such as income, credit, equity, property value and available loan programs. Refinancing may involve closing costs and does not guarantee a lower rate or payment. Explore the refinancing guide for more information.
-
If the index used by your ARM declines, your interest rate and principal-and-interest payment may decrease at a scheduled adjustment, depending on the margin, rate floor, caps and other loan terms. A decline in general market mortgage rates does not necessarily mean your particular ARM will adjust downward immediately.
-
Yes. An ARM’s rate calculation may be affected by rounding provisions, rate caps and the difference between the previous rate and the index-plus-margin calculation. Your total monthly mortgage payment may also change because of property taxes or homeowners insurance, even if your interest rate stays the same. Review your loan agreement and servicing notices to understand the reason for any change.
-
No. Prepayment penalties are not a standard feature of every ARM, and restrictions apply to many residential mortgage products. Review your loan estimate and closing documents to determine whether your specific loan has a permitted prepayment penalty and, if so, how it works.
-
For many closed-end consumer ARMs secured by a principal dwelling, federal servicing rules generally require an initial adjustment notice 210 to 240 days before the first payment at the adjusted rate is due. Later adjustments that change the payment generally require notice 60 to 120 days before the first payment at the new level is due, with certain exceptions. The rules and notice timing depend on the loan and circumstances. Review notices from your mortgage servicer so you have time to prepare for possible payment changes.
All loans subject to underwriting approval. Certain restrictions apply. Loan programs, terms and availability may vary. Adjustable-rate mortgages (ARMs) have an initial fixed-rate period, after which the interest rate and monthly payment may increase or decrease based on the applicable index, margin, rate caps and other loan terms. Borrowers should review all loan terms and disclosures before proceeding. This is not a commitment to lend.
CrossCountry Mortgage, LLC is an FHA Approved Lending Institution and is not acting on behalf of or at the direction of HUD/FHA or the Federal government.
CrossCountry Mortgage, LLC is not affiliated with or acting on behalf of or at the direction of the Veteran Affairs Office. Certificate of Eligibility required for VA loans.
