An adjustable rate mortgage (ARM) offers interest rates and payment amounts that fluctuate over the life of the loan. Usually, the interest rate is linked to an established market index such as the Treasury index. ARMs can differ in the frequency of these adjustments and some ARMs set an overall maximum interest rate and/or a maximum adjustment amount per period.
Most ARM programs begin with a fixed rate then adjust yearly thereafter. For instance, a 3/1 ARM provides fixed interest rate and payments for three years before adjusting with the market. Common adjustable rate mortgages are: 3/1 ARM, 5/1 ARM, 7/1 ARM, and 10/1 ARM.
An adjustable rate mortgage is used when the borrower wants the interest rate to fluctuate with the market, for instance when rates are high. Adjustable rate mortgages can also permit a buyer to purchase more real estate since ARMs are often issued at a lower initial rate than comparable fixed rate mortgages. Adjustable rate mortgages can be volatile since payments can increase over time, therefore individuals on a fixed income should avoid adjustable rate mortgages.