An adjustable-rate mortgage, or ARM, is a home loan whose interest rate starts fixed for an initial period and then adjusts periodically based on a market index. It typically offers a lower starting rate than a fixed loan, but your payment can rise or fall once the adjustment period begins.
How does an adjustable-rate mortgage work?
An ARM combines a fixed introductory period with a series of adjustments after it. A common structure is the 5/6 ARM, where the rate is fixed for the first five years and then adjusts every six months. During the fixed period, your rate behaves like a fixed-rate loan; after it, the rate resets on a schedule.
Each adjustment is set by adding a fixed margin to a benchmark index that reflects broad market rates. When the index rises, so does your rate, and your payment climbs. When it falls, your payment can drop. Caps limit how much the rate can move.
Key ARM terms to understand
- Index: the market benchmark your rate tracks, such as SOFR.
- Margin: the fixed percentage the lender adds to the index.
- Adjustment period: how often the rate can change after the fixed period.
- Rate caps: limits on how much the rate can rise at each adjustment and over the life of the loan.
Understanding the caps is essential. They set the worst-case scenario for your payment, which matters when you assess whether you could still afford the loan if rates climbed to their maximum.
ARM vs. fixed-rate mortgage
The core difference is who carries the risk of future rate changes. A fixed-rate mortgage locks your rate for the whole term, so the lender absorbs rate risk and charges a slightly higher starting rate. An ARM passes that risk to you in exchange for a lower introductory rate.
In practice, an ARM can save money if you sell or refinance before the fixed period ends, or if rates stay flat or fall. The danger is payment shock: if rates rise after your fixed period, your payment can increase significantly, which can strain a tight budget.
Fixed loans win on predictability, while ARMs win on early savings and flexibility. Your time horizon in the home is usually the deciding factor, along with how much payment uncertainty you can tolerate.
Who an ARM is for
ARMs suit borrowers who expect to move, refinance, or pay off the loan before the fixed period ends, and those who want a lower initial payment. They can also make sense when fixed rates are unusually high and you expect rates to fall. They are riskier for anyone planning to stay long term without a plan for rising payments.
Pros | Cons |
|---|---|
Lower introductory rate than a comparable fixed-rate loan | Payments can rise sharply once the fixed period ends |
Lower early payments can free up cash or help you qualify | Harder to budget because future payments are uncertain |
Can save money if you sell or refinance before adjustments begin | Complex structure with indexes, margins, and caps to track |
Payments may fall if market rates decline | Refinancing to escape a rising rate depends on future conditions and costs |
Managing ARM risk
Before choosing an ARM, model the worst case using the loan's caps, not just the introductory rate. Ask what your payment would be at the maximum rate and confirm you could still afford it. Keep an eye on your loan-to-value ratio and credit score, since both affect your ability to refinance later if you need to.
Have an exit plan. Many ARM borrowers intend to refinance into a fixed loan or sell before adjustments hit, but refinancing depends on future rates, your equity, and qualifying again through underwriting. Terms, caps, and index choices vary by lender, so compare the fine print carefully.
Frequently asked questions
The first number is how many years the rate stays fixed, and the second is how often it adjusts afterward. A 5/6 ARM is fixed for five years then adjusts every six months; a 7/1 ARM is fixed for seven years then adjusts once a year.
Rate caps set the limits. There is usually a cap on the first adjustment, a cap on each later adjustment, and a lifetime cap. Add the lifetime cap to your starting rate to estimate the highest rate, and payment, you could face.
It can be if you plan to move or refinance before the fixed period ends, or want a lower initial payment and can handle uncertainty. It is riskier if you plan to stay long term without a plan for rising payments. Weigh it against a fixed-rate loan.
Yes, many borrowers do exactly that before their rate starts adjusting. Refinancing depends on future market rates, your home equity, and qualifying again, and it comes with closing costs, so it is not guaranteed to save money.
Most modern ARMs track a published benchmark such as SOFR, plus a fixed margin set by the lender. The specific index and margin are disclosed in your loan documents and determine how your rate adjusts over time.
Updated July 21, 2026
Disclaimer
Dara provides this glossary for general educational purposes only. It is not financial, legal, or tax advice, and availability, fees, and terms vary by country and corridor.
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