An adjustable-rate mortgage (ARM) has an interest rate that may change periodically depending on changes in a corresponding financial index associated with the loan. Generally speaking, a consumer’s monthly payment will increase or decrease if the index rate goes up or down.
An ARM is considered a good option if the consumer plans to move prior to the end of the introductory fixed-rate period, wants a lower initial monthly payment, or if interest rates are expected to decline in the future. There are limits on how much interest rates and/or payments can increase each year or over the lifetime of the loan.
Typically, an ARM is expressed as two numbers: The first number indicates the length of time the interest rate remains fixed, while the second number indicates how often the interest rate is subject to adjustment thereafter. For example, in a 5/1 ARM, the “5” stands for an initial, five-year period during which the interest rate remains fixed, while the “1” shows the interest rate is subject to adjustment once per year thereafter.