What Is an Adjustable-Rate Mortgage (ARM) Loan?

Anna-Louise Jackson, Editor at LendingTree

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An ARM loan, or adjustable-rate loan, is a type of mortgage with an interest rate that fluctuates based on market conditions. This type of loan differs from a fixed-rate mortgage, which has a rate that remains unchanged for the entire loan term. Understanding how ARM loans work can help you decide if they’re right for you.

Key takeaways

An ARM loan has an interest rate that changes periodically — typically annually or every six months.
ARM loans usually have low “starter” or “teaser” rates.
Once the initial rate period ends, your monthly payments can go up.

How does an ARM loan work?

An ARM starts off with a low initial interest rate, which can mean lower monthly payments at the beginning of the loan. The lower starting rate can appeal to borrowers looking for more affordable mortgage payments initially or those who plan to sell or refinance their home before the first rate adjustment takes effect.

An ARM has four main components:

Index: A banking benchmark that fluctuates based on what’s happening in financial markets.
Margin: A set, extra percentage that the lender adds to the index during the adjustment period.
Rate caps: Limit how much your interest rate can increase during the adjustment period. ARM loans have a few different types of rate caps:
- First adjustment cap: This is how much your rate can increase during your first adjustment period.
- Subsequent adjustment cap: This is how much your rate can increase on future adjustment periods.
- Lifetime adjustment cap: This is how much your rate can increase throughout the life of the loan.
Initial rate period: When you first take out an ARM loan, the interest rate won’t change during the initial rate period, which is typically three, five, seven or 10 years.

ARM eligibility requirements

Since adjustable-rate mortgages are considered riskier loans, lenders typically apply stricter qualifying standards. The specific requirements vary by lender — but you’ll generally need at least a 5% down payment and a minimum credit score between 500 and 620 or higher to qualify, depending on the loan type.

Types of ARM loans

3/1 and 3/6 ARMs. These types of loans have a fixed interest rate for three years. After three years, the 3/1 rate will adjust yearly, and the 3/6 rate will adjust every six months.
5/1 and 5/6 ARMs. Fixed interest rate for five years. After five years, the 5/1 rate will adjust yearly, and the 5/6 rate will adjust every six months.
7/1 and 7/6 ARMs. Fixed interest rate for seven years. After seven years, the 7/1 rate will adjust yearly, and the 7/6 rate will adjust every six months.
10/1 and 10/6 ARMs. Fixed interest rate for 10 years. After 10 years, the 10/1 rate will adjust yearly, and the 10/6 rate will adjust every six months.
Interest-only ARMs. Some ARM loans offer an interest-only option, allowing you to pay only the interest due on the loan each month for a specified period, typically ranging from three to 10 years. One caveat: Although your payment is low because you aren’t paying anything toward your loan balance, your balance remains the same.
Hybrid ARMs. A hybrid ARM begins with a fixed rate and then converts to an adjustable-rate mortgage for the remainder of the loan term. The most common initial fixed-rate periods are three, five, seven and 10 years. Always read the fine print of an ARM loan offer to ensure you understand how much and how often your rate can adjust.
Payment option ARMs. Before the 2008 housing crash, lenders offered payment option ARMs, giving borrowers several options for how they pay their loans. The choices included a principal and interest payment, an interest-only payment or a minimum or “limited” payment. The “limited” payment allowed you to pay less than the interest due each month.

Home loan ARM rates

Many factors impact ARM rates, including your credit score, loan amount, down payment, location and loan type. ARM loan rates are typically lower than fixed-rate loan rates, especially in the initial period of the loan. Though ARM rates start off lower than fixed-rate loans, they could end up higher after the adjustments.

Pros and cons of ARM loans

Pros

You’ll generally receive a lower initial rate compared to comparable fixed-rate mortgages.
Your monthly payments are typically lower to start off.
These loans can be a good option to save cash if you plan to sell the home before the first adjustment period.

Cons

Your interest rate and monthly payment can go up.
You may face more stringent qualification requirements.
You may need to make a higher down payment.

Can you refinance an ARM loan?

You can refinance an ARM to a fixed-rate mortgage if you’re looking for more predictable mortgage payments. Some borrowers refinance out of an ARM before the initial rate period ends to avoid the rate hike. Refinancing a mortgage follows a similar process to getting a first mortgage — you’ll need to provide income and employment information, get an appraisal and pay closing costs.

Before refinancing, it’s important to weigh the potential benefits against the costs. Generally speaking, the lower the rate you can secure, the more financially worthwhile refinancing may be.

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Is an ARM loan a good idea?

ARM loans are worth considering for borrowers who are financially prepared to pay higher mortgage payments once the rate adjustments occur. They can also be a good option for borrowers who don’t plan to stay in their home for long and are therefore less concerned about future rate adjustments. If your budget is stretched thin or you prefer stable monthly payments, an ARM loan may not be the right fit for you.

Frequently asked questions

It depends on the loan type. For example, a conventional loan may be assumable if you agree not to convert it to a fixed-rate mortgage.

You may be able to repay an ARM loan early. However, some lenders will require you to pay fees or penalties to do so during the initial rate period. Be sure to understand any potential prepayment penalties before getting an ARM.

You generally don’t need to make a 20% down payment to get an ARM loan. You may be able to get an ARM with as little as 5% down.

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