What Is an Adjustable-Rate Mortgage (ARM)?

Learn about adjustable-rate mortgages, also known as ARMs, in this Howcast finance video with expert Gregory McGraime.

Transcript

An adjustable rate mortgage is a mortgage where your interest rate and your payment can change at some point in the future. And you may start out with one type of payment, and as interest rates fluctuate, at some point in the future, that interest rate and your payment may reset. And they can reset higher if interest rates went up, or lower if interest rates go down.

So let me use a specific example to put some context around this. There are tons of different types of adjustable rate mortgages, but let's look at a five year adjustable rate mortgage. And let's say my interest rate is five percent, and my payment is $2,000 a month. What happens at the end of five years? At the end of five years, my interest rate could go up, it could go down, depending on where rates are then.

And so I could see my payment potentially go up. Instead of being $2,000 maybe it jumps up to $2,500 a month, as an example. And so I run the risk of being in a situation where I was at a payment that was affordable, and through no control of my own, I've now moved to an interest rate and a payment that are much higher. And the $2,500 a month may not be affordable. So that's really how an adjustable rate mortgage works.

And if you get an adjustable rate mortgage, we want to be very clear you understand the terms. How high could that interest rate and payment go? When do they reset?

Now, it's not all bad. I mean an adjustable rate mortgage is appropriate for some people. If I was buying a home, for example, and I was only going to live there for three to five years, and then I was moving on, an adjustable rate mortgage might be the way to go. Because adjustable rate mortgages for that risk in the future, usually are giving you a lower interest rate and a lower payment now.

So for example, in that example, I buy a home. I'm staying in there three to five years. And I have a five year adjustable mortgage. At five years, that rate of payment can go up, but I don't care. I'm not going to be in the home anymore, so I'm not subjected to that risk.

Now, you may see an adjustable rate mortgage abbreviated as A, R, M. Or ARM. That's another term that the mortgage industry uses to describe an adjustable rate mortgage.

So the take home message here? If you're going to go with an adjustable rate mortgage, really be very careful you know all the terms, and make sure it's appropriate for your situation.

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