Adjustable-rate mortgage (ARM)

An ARM has a 30-year term with two periods: a fixed period and an adjustable period.

Fixed period: During the initial, fixed-rate period, typically the first 5, 7 or 10 years of the loan, your interest rate won’t change.

Adjustment period: This period comes after the fixed period. Your interest rate can go up or down.

For example: If you take out an ARM with a 5-year fixed period, the interest rate would be fixed for the first 5 years of the loan. After that, your rate would adjust up or down for the remaining 25 years of the loan.

Pros

• Lower rate for the first few years. You’ll typically have a lower rate for the first few years of the loan.
• Lower monthly payment for the first few years. Because your interest rate is typically lower, your payment could be lower too.

Cons

• Rates can go up. If your rate goes up, your monthly mortgage payments will go up, too.
• Less predictable payments. The possibility of future rate adjustments can be a concern for some home buyers.

An ARM can be a good option if you want to:

• Pay down your principal faster. Since you’ll typically have lower monthly payments the first few years, you could put the extra money you save toward your principal loan balance.

• Buy a starter home. The risks of an ARM are relatively minimal if you sell your home before the interest rate starts adjusting.

• Save and invest. You could put your monthly payment savings toward other financial goals.

5/1 And 5/6 ARMs: These loans offer a fixed interest rate for the first 5 years of the loan term. The second number represents the frequency of future rate adjustments after the first 5 years. With a 5/1 ARM, the rate adjusts once a year for the remaining loan term. With a 5/6 ARM, the rate adjusts every 6 months.

7/1 And 7/6 ARMs: These loans offer a fixed rate for 7 years. With a 30-year loan term, the initial fixed-rate period would last 7 years. Once the introductory period expires, you would make payments based on changing interest rates for the remaining 23 years on the loan.

10/1 And 10/6 ARMs: These loans have fixed rates for the first 10 years of the loan. After year 10, the interest rate will periodically fluctuate based on market conditions. A 30-year loan term means 20 years of changing payments.