What is an Adjustable-Rate Mortgage?

Before you purchase a new home, or refinance your current one, you’ll need to speak with your Loan Officer to determine which mortgage will work best for your financial and lifestyle goals. There are a variety of options out there depending on what you’re trying to accomplish to finance your home. Finding the right fit is an important step in the journey.

You may be familiar with the concept of a fixed-rate mortgage, where the interest rate you obtain is constant for the entire period you have your loan. Another option to consider is an adjustable-rate mortgage (ARM), which comes with a variable interest rate. Let’s learn more about ARMs so that you can decide if it is right for you.

Adjustable-Rate Mortgage Definition

An ARM is a home loan with an interest rate that adjusts over time based on the current market. Adjustable-rate mortgages typically start with a lower interest rate when compared to fixed-rate mortgages, so an ARM can be a great option if your goal is to get the lowest possible rate.
One consideration with ARMs is that the initial interest rate doesn’t last forever. They consist of two periods – the fixed period and the adjustable period.

• Fixed period: The initial fixed-rate period in which your interest rate won’t change. This is typically for 5, 7, or 10 years.
• Adjustment period: The second part of the loan is when your interest rate can increase or decrease depending on a corresponding financial index that’s associated with the loan. Your monthly payment may increase or decrease if the index rate goes up or down.

After the fixed period of your ARM loan, your monthly payment can change. Understanding the ARM loan will help make it less difficult to factor your payment into your budget. Taking the time to understand how ARMs work can help you be prepared and decide if it’s the right loan product right for you.

What Do Those Numbers Mean in an ARMs Name?

The mortgage industry is full of acronyms and interesting naming conventions. We have a helpful glossary of mortgage terms to help look up different definitions throughout your mortgage process. So, what exactly do those numbers mean in an adjustable-rate mortgage name?

ARM loans are named by the length of time the interest rate remains fixed, and how often the interest rate may adjustment after the fixed period. For example, consider our 5/6 ARM program. The 5 means there’s an initial 5-year period during which the interest rate remains fixed. The 6 means that the interest rate is subject to adjustment once every six months after the initial 5-year period.

Adjustable-Rate Mortgages and Rate Caps

Your mortgage interest rate is determined by a variety of factors. They include the current market and economic conditions, and personal factors such as your credit score. Before you start looking at homes, it would be a good idea to figure out what your credit score is. This is one of the primary metrics used to determine if you can qualify for a mortgage, and what terms you may qualify for (like your rate). Learn more about credit scores here.

When you use an ARM to finance your home, your interest rate will change periodically over the life of the loan after the fixed period. The good news is that there may be rate caps in place, which sets a maximum interest rate adjustment allowed during each period of the ARM loan. This helps homeowners have more manageable adjustments with each new rate change.

Now to the good stuff. There are four components that determine how much you’ll pay in interest: the index, the margin, the interest rate cap, and the initial rate period. Once the initial fixed period ends your interest rate will adjust to a new level calculated by adding the margin to the index. Your ARM margin will be disclosed to you during your initial loan application process and your Loan Officer will explain everything to you so you are comfortable with each piece of the puzzle. The margin will remain the same over the life of the loan, but the index rate will depend on what’s going on in the market.

That may sound a little complicated, but basically as the index changes, so will your interest rate. But your interest rate will never be more than your interest rate cap, which will protect you from dramatic changes.

ARM Loan Advantages

While several factors go into an adjustable-rate mortgage, they do allow many homebuyers to obtain the lowest interest rate possible and enjoy a low monthly mortgage payment during the fixed period.

ARM mortgages may be a great choice for you if:

• You’re looking for the lowest interest mortgage rate option possible.
• You are planning to move before your fixed period is over, so possible rate increases aren’t a concern.
• You want to have a lower monthly mortgage payment so you can pay more towards your mortgage principal each month.
• You think interest rates may go down in the future.

A lower interest rate often results in lower monthly payments, which can give you more financial flexibility and empowerment. ARM loans can be a great choice for homebuyers who are planning to move again in a few years. If you plan to sell the home before the adjustment period, any potential adjustments might not ever be experienced. Even if you are not planning to move soon, savvy savers will be able to take advantage of the lower monthly payments during the fixed period to build a savings or pay off other debt and safeguard against any future hikes.

Refinancing an ARM Loan

Of course, if your circumstances change or you opt to stay in the home instead of selling it, you do always have the option of refinancing your ARM mortgage. By refinancing into a fixed-rate mortgage, you can obtain an interest rate that will remain stable throughout the life of the new loan you take out. At that point, you’ll start paying off the new mortgage with your new terms. This is a good option if you think interest rates will move down in the future.

Qualifying for an ARM loan

An adjustable-rate mortgage will require your lender to look at the same factors as any other loan when qualifying, including your credit score, income, and personal debt. We offer ARM options for a variety of different loan programs, such as Jumbo home loans, Conventional home loans, FHA home loans, and VA home loans^*.  Each loan program has different qualifying criteria and down payment requirements, so find a local Loan Officer to help you navigate the options.

Wrap Up

Ready to learn more? An adjustable-rate or a fixed-rate mortgage is just one thing you’ll need to decide on when financing a home. But it’s an important one, and something your Loan Officer will be able to help you figure out. As you explore the types of mortgages, consider what makes the most sense for your personal situation and your future goals.

Find a local Loan Officer near you to discuss getting pre-approved to get started.


*Certainty Home Lending has no affiliation with the US Department of Housing and Urban Development, the US Department of Veterans Affairs, the US Department of Agriculture or any other government agency