Adjustable-Rate Mortgage: Pros and Cons

An adjustable-rate mortgage, or ARM, is a home loan that starts with a low fixed-interest "teaser" rate for five to 10 years, followed by periodic rate adjustments. ARMs are different from fixed-rate mortgages, which keep the same interest rate for the life of the loan.

How does an adjustable-rate mortgage work?

With an adjustable-rate mortgage, your payments can increase or decrease with interest rate changes, based on the terms of your individual loan and a benchmark rate index. In some cases, choosing an ARM over a fixed-rate mortgage could be a solid financial decision, potentially saving you thousands of dollars. Ask loan officers to explain ARM risks and exactly how much the payments could increase.

» MORE: See the best adjustable-rate mortgage lenders

Fixed-rate mortgages are more commonplace. But ARMs can be an option for home buyers who know they'll have the loan for only a few years. Carefully weigh the pros and cons before applying.

Common ARM terms are 5 years, 7 years and 10 years. A few lenders offer 3-year ARMs, although this is not a widely available product.

» MORE: Compare adjustable and fixed-rate mortgages

Adjustable-rate mortgage pros

Low payments in the fixed-rate phase

An ARM offers potential savings in the initial, fixed-rate period. With a 5-year ARM, for example, your introductory interest rate is locked in for five years before it can change. That gives you five years of predictable, low payments.

The initial low rate might also allow you to qualify for a larger mortgage than you could with a fixed-rate loan. Just ask yourself if you could make higher monthly payments in the future if necessary.

Flexibility

An ARM can be a good idea if your life is likely to change in the next few years — for instance, if you plan to move or sell the house. You can enjoy the ARM’s fixed-rate period and sell before it ends and the less-predictable adjustable phase starts.

Rate and payment caps

ARMs have caps that limit how much the mortgage rate and your payment can increase. These include caps on how much the rate can change each time it adjusts and the total rate change over the loan’s lifetime.

Your payments could decrease

If interest rates fall and drive down the index against which your ARM is benchmarked, your monthly payment could drop. If you believe this is likely, you may be tempted to choose an ARM — but it's always safer to make this decision based on your personal circumstances, not what you think the market will do.