Adjustable Rate Mortgages (ARMs)

An adjustable rate mortgage (ARM) has an interest rate that varies over time. The initial rate is usually lower than that of a fixed mortgage, but that initial term is only for an introductory period of a time, usually for a year or less. After that, the interest rate will move up or down as the current mortgage rate moves up or down. Sometimes, there is a rate cap that restricts the extent to which interest rates can increase.

A fixed mortgage for a person with good credit, on the other hand, will carry an interest rate that is probably within a few basis points of the current mortgage rate.

Whether an ARM or a fixed mortgage is most beneficial is dependent on what the current mortgage rate is when you are getting your mortgage. If the current mortgage rate is very low, then it is better to lock in that low rate with a fixed rate mortgage, even though the ARM will be offering a teaser rate that is probably even lower. As that teaser rate is good only for a short time, after a year or so, you will be paying more as the current rate escalates.

If the current mortgage rate is high, however, an ARM offers the benefit of the low introductory rate, as well as the benefit of decreasing over time as the interest rate decreases. The introductory rate may be as great as a full percentage point lower than the current mortgage rate, something that could offer some big savings in the months immediately following your home purchase.

Since the current mortgage rate has dropped to record lows, ARMs have decreased significantly in popularity. In 1985, when the current mortgage rate was in the low double-digit figures (between 10 and 12 percent), 50 percent of conventional, single family mortgages were adjustable rate mortgages. In 2003, the percentage of mortgages with adjustable rates had dropped to 19 percent.