Interior of home financed with an ARM

Adjustable Rate Mortgages (ARMs): Everything You Need To Know

Holly Shuffett6 minute read
November 12, 2021

Personalization is important – from tailoring our clothing to adding personal touches to our coffee orders. With so many options at our disposal, it’s no wonder we want the one that is customized to our individual needs.

The same way you’d shop around before settling on a final decision in other areas of your life, you should take a look at all of the different types of home loans when entering the world of home buying – particularly adjustable-rate mortgages, what they have to offer and if they’re right for you.

What Is An Adjustable-Rate Mortgage?

An adjustable-rate mortgage is a home loan option where the interest rate has an initial low and fixed period, before eventually adjusting to the market and shifting to a higher or lower rate. The initially low rate in the beginning of the loan’s term is usually the most attractive draw for borrowers, as it allows more flexibility and offers temptingly low monthly payments.

Unlike a fixed-rate mortgage – where the rate of interest remains steadfast throughout the life of the loan – an ARM’s rate is set below the market rate and adjusts accordingly after the initial period is up. At the offset, fixed-rate mortgages typically have higher interest rates than an adjustable-rate mortgage, whereas ARM rates usually spike after the beginning of the loan.

While the amount of principal and interest paid may vary across your monthly payments with a fixed-rate mortgage, the overall total payment remains the same and you know what to expect with your monthly payments. ARMs on the other hand, are much more vulnerable to change, and if an ARM is held long-term, its rate may eventually exceed the going rate for fixed-rate mortgages.

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How Do ARMs Work?

Adjustable-rate mortgages are typically offered in 30-year terms, though this can vary from lender to lender. Whether the rate of interest is calibrated on a monthly or a yearly basis, after the initial low-rate period, it can also vary across different types of ARMs.

What do adjustable-rate mortgages entail for the home buyer? If you’re looking to purchase a home soon and think an ARM is a good fit, keep in mind that they’re more complicated than most fixed-rate loan options. Depending on your circumstances and the going market rate, you may be able to score a better deal. To assess whether an ARM would be right for you, look at the loan’s rate period and the overall life of the loan.

The rate period is that initial period of time at the beginning of the loan when the interest-rate is lower than a standard fixed-rate loan. If you’re looking for a short-term living situation, an ARM could be a good fit. You should also pay close attention to the rate period to determine how long you’ll have before the interest rate is subject to change. Assess if a fluctuation in the rate at that time would still be manageable for you and your situation.

You should also examine the overall life of the loan and how it compares to that of the fixed-rate mortgage or other loan options. For example, a 30-year fixed-rate mortgage could be a better deal over time than a 30-year ARM, even with the initial low interest rates due to rising market rates. On the other hand, if you’re looking to refinance, the flexibility of an ARM could reduce your mortgage payments and save you loads in interest, depending on the market.

Common Types Of ARM Loans

ARMs come with a variety of options to choose from. In most cases, adjustable-rate mortgages are represented by a ratio – for example: 5/1 or 7/6. The numerator represents how long the fixed period is and the denominator indicates how frequently the interest rate will change. The fixed-rate period will vary across lenders, but it typically falls between 1 – 10 years’ time.

Let’s have a look at some of the most common types of adjustable-rate mortgages: 

  • 5/1 ARM – A 5/1 mortgage has a fixed-rate period of 5 years with an adjustable rate that will fluctuate in accordance with the market for the remainder of the loan’s term. With a 5/1 loan the rate of interest will adjust annually.
  • 7/6 ARM – The fixed period for a 7/6 loan is 7 years with a rate adjustment once every 6 months for the remaining life of the loan – in this case, your rate will adjust every 6 months for the remaining 23 years.
  • Convertible ARM – A convertible ARM allows the borrower to switch over to a fixed-rate mortgage after a given period. Convertible adjustable-rate mortgage loans are a great way to save money on interest if the market is leaning toward falling rates. However, most lenders will charge a fee to swap over to the fixed-rate mortgage after the initial period is up.

How ARM Rates Are Set

The rate of interest in adjustable-rate mortgages is subject to change depending on general market conditions – which is reflected through an ARM’s index – and the margin set by your lender. An ARM’s margin is a specified amount of percentage points that will be added to the index to set your loan’s rate. This value shouldn’t change after finalizing your loan.

Unlike the margin, the same way that the market is constantly evolving, so is the index, and thus, the ARM’s rate of interest. By combining the index with the margin, you can determine the interest rate once the fixed period has ended.

While adjustable-rate mortgages are seen as riskier when compared with the predictability of a fixed-rate mortgage, there are safeguards in place to protect the borrower from any severe spikes in interest. Rate caps – or limits on just how much an interest rate can increase during an adjustment period – can give you a little more peace of mind when it comes to an unpredictable market. Some ARMs may also offer caps on your total monthly payments which can keep things from getting too overwhelming.

Another surety that some ARMs may have in place is a lifetime cap, or a rate ceiling, which is an overall maximum that the interest rate won’t be able to exceed during the lifetime of the loan.

Who Needs An Adjustable-Rate Mortgage?

There are several important things to consider when figuring out if an ARM is right for you:

  • How long are you planning to live on the property?
  • How much you can afford as of right now?
  • What direction is the market heading in?

Short-term homeowners are great candidates for ARM loans, which will have that low interest rate – lower than that of a fixed-rate mortgage – in the beginning. So, if you’re planning on moving after just a few years, an ARM will undoubtedly save you some money in interest.

If you’re a planner you may have the gut instinct to settle into a fixed-rate mortgage – but an ARM could be the smarter choice. If you currently have enough money, or close to enough, saved up to pay off the loan before the rate can adjust, an ARM will save you on interest. While this may not be much of an option for most of us, those of us who can pay off the loan or take on accelerated payments are prime candidates for an adjustable-rate mortgage.

Regardless of your circumstances, however, since ARMs are influenced so heavily by the market, you should always keep an eye on interest rates. If you anticipate a drop, an ARM may be the way to go. But steady or rising rates might indicate that a fixed-rate mortgage is a better loan option for the time being.

Pros And Cons Of ARM Loans


  • Initial period: The affordability of the initial period’s payments is perhaps the biggest draw for many interested in an ARM. The low rates can save the borrower hundreds per month for the first few years of the loan’s duration.
  • Can secure a larger loan: Due to the low rates and the low monthly payments during the initial period of an ARM, borrowers may be able to qualify for a larger loan than with a different loan option.
  • If the market favors you …: If interest rates fall, your monthly payments could drop even lower than before. On top of that, you won’t have to refinance in order to reap these savings benefits! 


  • Instability: For those of us who love planning or stability, the very thought of an ever-changing monthly payment might be a huge turnoff.
  • Not great long-term: Long-term ARMs will typically wind up costing you more than a fixed-rate mortgage, unless you take on accelerated payments or sell before rates can rise.
  • If the market doesn’t favor you …: Monthly payments can get significantly more expensive than with a fixed-rate mortgage. In severe cases, the market could even cause your rates to double.

How To Apply For An Adjustable-Rate Mortgage

If an ARM sounds right for you, here are some of the qualifications as of 2021:

  • 5% minimum down payment
  • A FICO® credit score minimum of 620
  • Maximum 50% debt-to-income (DTI) ratio
  • Maximum loan-to-value (LTV) ratio of 95%

The Bottom Line

Figuring out what works best for you is a challenge that we face every day – but in the end, it’s usually well worth it. Understanding your situation and how an ARM would or would not benefit you is the key to finding a loan that will save you the most money and help you get one step closer to becoming a proud homeowner.

If you think that an adjustable-rate mortgage is right for you, feel free to take that step and get started with your mortgage approval process today.

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Holly Shuffett

Holly Shuffett is a freelance writer for Rock Companies where she usually covers lifestyle and personal finance topics. Holly is also an Oakland University senior pursuing public relations and journalism, and she is interested in learning more about the entertainment and travel industries. In her free time, Holly serves as the secretary for Dance Marathon at OU, is a member of PRSSA, and tutors part time for