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Definition of an Adjustable Rate Mortgage (ARM)

By Gretchen Wegrich Updated on 7/29/2013

woman holding percent signAn Adjustable Rate Mortgage is a type of mortgage in which the initial mortgage rate of the loan remains fixed for a period of time --typically 3, 5, or 7 years. After this period, the rate begins to shift up or down depending on changes in the mortgage marketplace. ARM rates are pegged to an interest rate index, often the current prime rate. After the initial period, the interest rate on the loan will adjust upward or downward at regular intervals, following this index.

Benefits of ARM loans

What is the benefit of an adjustables rate mortgage? Simply put, an ARM typically comes at a lower rate than a conventional fixed mortgage. You’ll be given a highly favorable low rate for the first 3, 5, or 7 years, which allows many homebuyers to recoup costs and expenses or save money for later bills.

An ARM loan makes sense if you plan to pay off your mortgage quickly or sell your home within a few years. Learn more about ARM loans before you decide whether this type of loan is right for you.

ARM loan considerations

If you decide to take on an ARM loan, planning ahead is crucial. You’ll likely end up paying a higher interest rate once the initial rate begins to adjust. It’s rare that an adjustable rate mortgage would shift downward at the end of the initial period. Be prepared to make higher payments unless you refinance your ARM loan.

Many borrowers have been taken by surprise with significantly higher payments when their interest rate adjusts. At this point, many borrowers either sell their home or refinance their home mortgage loan to a more favorable rate.

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About The Author:
Gretchen Wegrich
Gretchen Wegrich is an editor at Lender411. She specializes in mortgage basics, personal finance and green living. She graduated with a bachelor's degree in writing from University of California, San Diego and previously worked at the Santa Cruz Sentinel. Contact her at gretchen@lender411com.

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