Also known as variable-rate mortgages, an adjustable-rate mortgage (ARM) offers interest rates that can change periodically, depending on factors such as the financial index associated with your loan. Contrast this with a fixed-rate mortgage where your interest rate remains the same throughout the lifetime of the loan.
Adjustable-rate mortgage rates can increase or decrease, meaning your monthly payment can too. Your loan will have an initial rate when your payment typically remains the same for a stated period that can range up to seven years or more.
Once that period is over, your rate can change depending on the terms set forth by your lender. The time between rate changes — called the adjustment period — will appear in the fine print, so you’ll know exactly when it may go up or down. Typically, ARM interest rates adjust annually after the initial fixed period.
A rate cap puts a limit on how much your interest rate can go up.
There are two types:
Keep in mind that a drop in interest rates doesn’t mean your monthly payments go down (or up) right away. Some lenders may hold onto some or all of the rate decline and move it over to the next adjustment period — referred to as a carryover.
For example, if your rate cap is 1 percent and interest rates went up by 2 percent, your lender can hold onto the “extra” 1 percent and increase your monthly payment even if the index rate hasn’t gone up.
ARM loans have a few requirements which are similar to other types of mortgages.
Loan amount Typically, homeowners can borrow up to $510,400 for a conforming ARM (limits may be higher in areas with higher home prices). You can take on a jumbo ARM which exceeds the conforming loan limit, though both these types of loans will depend on your creditworthiness.
Credit history The higher your credit score, the more likely you’ll be approved for a loan with competitive interest rates. Lenders will also look at other factors such as your payment history, other loans and income.
Down payment Ideally, you’ll want to put down a 20 percent down payment to avoid PMI (private mortgage insurance) but most conventional ARM loans allow as little as a 5 percent down payment. Government backed loans such as FHA or VA loans may have even lower minimum down payment requirements.
ARM loans vary depending on how long your initial fixed-rate lasts plus how frequent your adjustment period is afterwards. The most common ones you’ll find are 5/1, 7/1 and 10/1 — the first number is the initial fixed-rate period, the second is the floating-rate or adjustment period.
This type of adjustable-rate mortgage offers a five-year initial fixed rate then adjusts every year afterwards. This type of ARM generally offers lower initial interest rates than many fixed-rate loans.
Borrowers who don’t want a long-term mortgage — such as those who are refinancing and have just a few years left on their loan — can benefit the most from a 5/1. However, if you’re unsure whether you can pay off the loan amount before the rate reset or may not move within that time, you’re at risk of an increased monthly payment.
The 7/1 ARM can be the best of both worlds — a seven-year initial period which can offer homeowners a lower fixed rate for a longer period of time. The benefit is that you can expect significant savings in interest, plus you can enjoy the rate for seven years, which begins to approach the 11-year average U.S. homeowners stay put in one place.
At the end of the seven years, you are exposed to a substantial interest rate increase throughout the lifetime of your loan. However, rates may fall further during this period, so you might benefit as well with a lower payment after the reset.
A 10/1 ARM loan offers a 10-year initial fixed period and rate adjustments every year afterwards. This type of loan offers savings via your initial rate and a longer period to protect homeowners from fluctuations in interest rates. However, if rates go down (which can happen during this longer timeframe) within your initial loan period, your payments won’t go down until the rest year.
Here are a few scenarios when it could make more sense to take out an ARM loan:
When the Fed announces rate increases or decreases, ARM loan rates could change when their initial or adjustment period is over. That means your rate could drop if the Fed announces interest rates decrease during your adjustment period. Or the rate could rise.
As mentioned above, lenders might not drop rates even if the index decreases. That’s why it’s important to look at whether you can afford the higher payments, whether rates go up or down. Even if your initial payment is lower, you’ll most likely face higher rates once it’s over.
When looking for the best adjustable rate mortgage rates, doing your due diligence helps. This means checking your credit report and your income situation to see where you stand — it’ll give you an insight into what rates you might qualify for.
Then shop around. Bankrate has compiled information from numerous lenders all over the country to bring you personalized rates. Before deciding, take a look at various aspects of the loan such as the APR, payment or interest caps and any fees associated with the loan.
Refinancing an ARM loan is a common way to help with the uncertainty of fluctuating rates — fixed-rate loans are a good fit for this reason. What happens is that when you refinance, you’ll be offered a rate (which can be higher than your initial rate) which stays the same throughout the lifetime of the loan.
There are fees associated with refinancing, so make sure the benefits outweigh the costs you could pay. You may even want to refinance into another ARM, if the timing and rate work for you.
A few scenarios when it makes sense to refinance include:
An ARM might be a good refinance choice for borrowers who have a clear timeframe for selling their home or paying off their mortgage within the initial fixed-rate period.
However, keep in mind that you might not be able to sell your home in time before your rate goes up. Keep in mind that millions of homeowners were unable to refinance their mortgages during the real estate meltdown of a decade ago because they had negative equity.
You’ll want to look carefully at index rates, as well as the lender’s index margin. Some loans also have prepayment penalties, so check the fine print before signing on the dotted line if your goal is to pay off your mortgage off as quickly as possible.
|Loan Type||Purchase Rates||Refinance Rates|
|The table above links out to loan-specific content to help you learn more about rates by loan type.|
|30-Year Loan||30-Year Mortgage Rates||30-Year Refinance Rates|
|20-Year Loan||20-Year Mortgage Rates||20-Year Refinance Rates|
|15-Year Loan||15-Year Mortgage Rates||15-Year Refinance Rates|
|10-Year Loan||10-Year Mortgage Rates||10-Year Refinance Rates|
|FHA Loan||FHA Mortgage Rates||FHA Refinance Rates|
|VA Loan||VA Mortgage Rates||VA Refinance Rates|
|ARM Loan||ARM Mortgage Rates||ARM Refinance Rates|
|Jumbo Loan||Jumbo Mortgage Rates||Jumbo Refinance Rates|