Adjustable-rate mortgages (ARMs) have a variable interest rate and monthly payments that are recalculated on a regular basis to reflect changes in the market interest rate.

The initial rate on an ARM is fixed for a specified period. The shorter the initial fixed period, the lower the initial rate can be. The lower rate reflects the fact that the lender assumes less risk of potential increases in the market interest rate, and the borrower isn’t paying for interest rate protection that he or she doesn’t need. This translates into a lower monthly payment than for a similar-term fixed-rate mortgage.

Key elements of adjustable-rate mortgages:

  • Interest rates that are typically lower than those of fixed-rate mortgages
  • More money can be borrowed than with a fixed-rate mortgage
  • If interest rates fall, the borrower benefits
  • Useful in situations where unpredictable interest rates make fixed-rate mortgages difficult to obtain
  • A disadvantage of ARMs is that they expose borrowers to the risk that market interest rates may rise in the future, resulting in increased monthly mortgage payments.