Adjustable Rate Mortgage (ARM): Changing Interest Rates & Payments

In this article:

• Adjustable-rate mortgages (ARM loans) have a set interest rate for an introductory period and then the rate adjusts every six months thereafter.
• The introductory rate period for ARM loans can last for 3, 5, 7, or 10 years.
• ARM loans are often a good choice for homeowners who plan to sell after a few years.

If you’re buying a home using a mortgage loan, you’ll need to decide what type of loan you want to use. This includes choosing between a loan with a fixed interest rate or one with a variable interest rate, called an adjustable-rate mortgage (ARM). For many people, the best loan is the one that charges the least amount of interest for the period you own the home. Here’s what you need to know about adjustable rate mortgages.  

What is an adjustable-rate mortgage (ARM)?

An adjustable-rate mortgage, or ARM, has an introductory interest rate that lasts for a set period of time and adjusts every six months thereafter for the remaining loan term. Introductory periods can range between three and 10 years and most ARMs have a 30-year term. ARMs are also known as a variable rate or floating rate mortgage.

How does an adjustable-rate mortgage work?

When you take out an adjustable-rate mortgage, you’ll pay a fixed introductory rate for a set number of years. These rates are typically very low–much lower than the interest rate on a fixed-rate mortgage loan. In ARMs opened prior to 2023, it was typical that after your introductory period, your rate would change every year. Today, rates change every six months. When shopping for an ARM, you’ll see your loan options represented with two numbers with a slash in between. For example, a 3/6 ARM. The 3 represents how many years your introductory period will last. The 6 represents how many months will pass between each rate change. 

Every time you reach an adjustment period, your interest rate will change. How high it will go depends on the prime rate—a rate used by banks and lenders across the industry as a benchmark for borrowers with good credit. While your rate will almost certainly increase after your introductory period ends, there are limits to how much your rate can go up during each adjustment period. There’s also an overall cap to how much your rate can increase throughout your 30-year loan. And, there’s a payment cap in place to prevent extreme rank hikes from spiking your monthly payment.

How are interest rate adjustments determined?

After your introductory period ends, your rate will change every six months. Each time, your updated interest rate is calculated by combining two rate inputs: the ARM index and the ARM margin.

ARM Index

The ARM index is a benchmark interest rate that lenders reference to determine the amount of interest they should charge for a loan. This rate is commonly referred to as the prime rate which is the best available interest rate for the current economic condition. It's updated frequently, about every six weeks, in response to changes in the federal funds rate. Because the prime rate is not a mandatory rate for lenders to use, just a reference rate, interest rates often vary between lenders using their own ARM indexes.

ARM Margin

This is a fixed interest rate percentage you’ll pay above and beyond the ARM margin rate. For example, your ARM margin may be 2% to 3%, which gets added on top of the ARM index to make up your new rate. 

Example: If at the time of adjustment, the index rate is 3 percent and your margin is 2 percent, then your fully indexed interest rate would be 5 percent during that adjustment.

Interest Rate Caps

Three different caps limit how much your interest rate can change during the adjustment period: the initial cap, the periodic cap, and the lifetime cap. 

The initial cap is the amount the interest rate can fluctuate in the very first adjustment. 

The periodic cap is defined as the maximum amount each interest rate adjustment can be after the initial rate change. 

The lifetime cap determines the maximum amount the interest rate can change over the entirety of the loan period. 

While your rate will change regularly, how it works shouldn’t be a surprise to you. When you apply for an ARM loan, your loan estimate will detail your introductory rate, how often your rate will adjust, whether there are any interest rate or payment amount caps and your ARM margin. Be sure to ask your lender if anything is unclear. 

On Zillow, we define the specifics of your individualized ARM mortgage quotes. We highlight how long the rate is fixed, the initial interest rate, the index type, the margin, the initial cap, the periodic cap and the lifetime cap.

When to consider an ARM loan

ARM loans are best suited for home buyers who plan on selling or refinancing the home during the introductory period, or when it’s likely that interest rates are on the decline–though this can be hard to predict. 

Let’s say your introductory rate is three years. If you only plan to live in the home for two years, it may be worth taking advantage of the low introductory rate. Similarly, if you’re working to improve your credit over the course of a year or two, you may be able to refinance your mortgage into a fixed-rate loan before your introductory period ends. 

If you anticipate significant appreciation during the introductory period, it may be worth starting with an ARM and refinancing into a fixed-rate loan once you have earned that equity.

Adjustable rate vs fixed rate mortgages

An adjustable-rate mortgage (ARM) has an interest rate that changes periodically throughout the life of the loan. A fixed-rate mortgage has an interest rate that remains unchanged until it’s paid off. If you plan on owning the home for a long time or if you are risk averse, a fixed rate is typically preferred, as an ARM’s rate fluctuates based on market conditions. Learn more about adjustable-rate vs fixed-rate mortgages.

Types of adjustable rate mortgages

There are multiple types of ARMs to choose from, including hybrid, interest-only, and payment-option adjustable rate mortgages.

Hybrid ARMs

Hybrid ARMs are the type of variable rate mortgage you’re probably most familiar with. There’s an initial fixed-rate period, and once that has expired, the rate will adjust repeatedly on a predetermined schedule. Here are some common types of hybrid ARMs.

3 Year ARM

A 3-year ARM has a low, fixed introductory rate that lasts for three years. Most 3-year ARMs include a rate cap for each adjustment period, as well as a lifetime cap over the full 30-year loan term. The best time to consider a 3-year ARM is when the APR on a comparable fixed-rate mortgage is high. A 3-year ARM can be a good fit for buyers who plan to sell or refinance after the first three years. If the value of the home increases significantly before the 3-year period ends, you may be able to leverage your equity into a better rate in a refinance. Keep in mind, though, that the real estate market can be unpredictable.

5 Year ARM

In a 5-year ARM, your low initial fixed interest rate lasts for five years. After that, you’ll have a variable rate that updates during each adjustment period. Most 5-year ARMs have a rate cap for each adjustment period, as well as a lifetime cap. 

7 Year ARM

A 7-year ARM includes an introductory period of seven years. Like other hybrid ARMs, the initial interest rate is low and most include a maximum rate cap for each adjustment period and a lifetime cap.

10 Year ARM

Like other hybrid ARM loans, the introductory period is detailed in the name, 10 years. The initial interest rate is low and fixed for the first 10 years. With most 10-year ARMs you can expect a maximum rate cap for each adjustment period and a lifetime interest rate cap for the full loan term (30 years).

Interest-only (I-O) ARM

In an interest-only adjustable-rate mortgage, you’ll be able to make interest-only payments for a specific amount of time, usually between three and 10 years. Once this period expires, you’ll make regular combined principal and interest payments, which you can expect to be significantly higher. Note that like any other ARM, this loan will continue to have periodic rate adjustments.

Payment-option ARM

A payment-option adjustable-rate mortgage gives the borrower options in making payments. This includes making standard principal and interest payments, making interest-only payments or even making low payments that don’t cover the principal and interest. While this type of loan gives plenty of flexibility, it can be risky for undisciplined borrowers, as you’re simply delaying payments you’ll have to make later, while interest continues to accrue.

Pros & Cons of ARM loans

Like any financing option, there are advantages and disadvantages to ARMs. Here are some of the benefits:

Pros of ARMs

Low introductory rates: Your initial interest rate will most likely be lower than a fixed-rate option, saving you money on your monthly payment for the first few years of the loan.

Ideal for short-term borrowing: If you plan to sell or refinance before the first adjustment period, you can enjoy significant interest savings as compared to a fixed-rate loan.

Interest rate and payment increases are capped: While your interest rate will fluctuate over time, most ARMs include built-in caps on interest rate and payment increases so you won’t be too surprised by increased monthly responsibilities.

Cons of ARMs

Payments increase: If market rates are high when your initial period ends, you may face significantly higher monthly payments.

Higher-risk loan option: ARMs lack the flexibility of fixed-rate mortgages, as you don’t know what will happen with market rates.

Complex repayment: Since your rate changes every six months, it can be time consuming to manage the details. 

How to Choose The Right ARM?

If you’re thinking about getting an ARM, here are a few considerations. First, decide how long you plan to stay in your home. If you’re going to own your home for just a few years, an ARM probably makes sense. If you are buying your forever home, a fixed-rate mortgage is likely a better option. 

Second, compare different ARMs from different lenders to find one that has the best terms for you. Be sure to compare initial interest rates, length of initial period, the index rate, the margin rate and any payment and interest rate caps. Your lender can help you with this process. At Zillow Home Loans*, you can get pre-qualified with us in as little as five minutes, with no impact to your credit score.

Finally, make sure you can afford the monthly payments, even when the interest rates increase. Have a plan in place to ensure you’ll be able to pay every month.

*An equal housing lender. NMLS #10287