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Adjustable-Rate Mortgages: What First-Time Buyers Should Know

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90% of first-time home buyers use a 30-year fixed-rate mortgage to finance their home. The other ten percent use adjustable-rate mortgages (ARM).

ARMs are a standard, regulated mortgage product. They’re not evil or dangerous or a mortgage type to avoid. For many first-time buyers, choosing an ARM vs. a fixed is more appropriate.

This article discusses ARMs, what they are, and how they work. 

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What Is an Adjustable-Rate Mortgage?

An adjustable-rate mortgage (ARM) is a home loan whose interest rate can change over time.

Adjustable-rate mortgages are available for:

  1. Conventional mortgages
  2. FHA mortgages
  3. VA mortgages

ARMs are not available for USDA mortgages and some credit union mortgage products.

Adjustable-rate mortgages are 30-year loans with standard eligibility requirements. Lenders verify income, payment history, and credit score as part of an adjustable-rate mortgage approval.

ARMs are available as low- and no-down payment mortgages.

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Fixed vs. Adjustable Rate Mortgages

ARMs are similar to fixed-rate mortgages. Both ARMs and fixed-rate loans:

  • Pay off in 30 years or fewer
  • Follow standard mortgage approval guidelines
  • Get underwritten and approved online

Adjustable and fixed-rate mortgages can finance any residential property, including standalone houses, condos, townhomes, multi-units, and manufactured homes.

The difference between ARMs and fixed-rate mortgages is that ARM mortgage rates can change over time, whereas fixed-rate mortgage rates cannot. Home buyers using ARMs share risk with the bank and, therefore, get more favorable lending terms such as lower overall rates.

According to Freddie Mac, ARM interest rates average 0.64 percentage points lower than 30-year fixed-rate mortgages, yielding $450 in annual savings per $100,000 borrowed.

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How Much Can You Save With a 5-Year ARM?

This table compares ARM and 30-year fixed payments at today’s mortgage rates.

Loan SizeAnnual Savings

How Do ARM Loans Work?

Adjustable interest rates are an optional mortgage loan feature. 

Because their interest rates can change over time, adjustable-rate mortgages are strictly regulated. Regulation protects homeowners from rising rates and payments, which can spark default and foreclosure.

The home buyer selects the number of years until its loan’s first adjustment. The most common selection is five years, which creates a 5-year ARM.

Home buyers can also choose 3-year ARMs, 7-year ARMs, and 10-year ARMs.

After the buyer selects a starting period, the lender assigns a starting interest rate. Shorter ARMs get lower interest rates. Then, the loan is given a margin and an index.

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Margin and Index

The margin is a constant used to calculate future interest rate adjustments. For most conventional ARMs, the margin is 2.75 percentage points.

The index is a variable used in the same equation. Conventional ARMs use the 1-year U.S. Treasury Rate, which is currently near 2.00 percent.

When an ARM adjusts, its new interest rate is the sum of the margin and the index. However, the government limits how much an ARM’s interest rate can change.

ARM limits are known as caps.

Caps hold ARM interest rates within a safe, controlled range. A typical cap prevents rates from moving up or down by more than 2 percentage points. 

Caps on a 5-year ARM look like this:

  • After five years, the adjustment is limited to ±5 percentage points
  • Every year after, the adjustment is limited to ±2 percentage points

Non-conforming ARMs, including jumbo and portfolio loans, may use different indexes, margins, and caps. Ask your lender for details.

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Types of ARMs

The standard adjustable-rate mortgage is a conventional mortgage backed by Fannie Mae and Freddie Mac. It accounts for the majority of ARM issued by mortgage lenders. 

Other ARM types also exist. Let’s review them.


FHA and VA ARMs are adjustable-rate mortgages offered through the FHA or VA. FHA and VA ARMs can adjust every year in their 30-year life. They carry government-mandated caps of 1 percentage point per year and five percentage points over the life of the loan.

Hybrid ARM

Hybrid ARMs are another name for conventional mortgage ARMs. The term “hybrid” refers to the loan’s adjustment schedule, which causes it to resemble a fixed-rate mortgage for a few years and then an adjustable-rate mortgage later. 

Hybrid ARMs are the standard ARM program used by first-time buyers. They’re rarely called “hybrid ARMs.”


Interest-only ARMs are adjustable-rate loans that don’t require a monthly principal payment. Government regulation reduced the availability of interest-only loans between 2008-2012.

Today, they’re only available from local banks as specialty products. 

Payment Option

Payment option ARMs were adjustable-rate loans that let homeowners choose from four payment options – full payment, partial payment, interest-only payment, and minimum payment. Sometimes called Option ARMs, the payment option ARM was retired in 2008 for poor performance.

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How Do You Know if ARM Loans Are Right For You?

Since 2000, ARMs have accounted for approximately 10% of all conventional mortgages made, 

and they’re less common when mortgage rates are low. There are two scenarios, though, when homeowners should always choose an ARM.

Scenario 1: Use an ARM when you’re selling or refinancing within five years

When you know that you will sell your home within five years or are confident that you will refinance your mortgage, a 5-year ARM can reduce your interest rate and save you money on your home loan.

The typical 5-year ARM sells at 62 basis points (0.62%) below comparable fixed-rate mortgages, saving $450 per year per $100,000 borrowed at today’s rates. 

Scenario 2: Use an ARM when you’re comfortable sharing interest rate risk with your lender

ARMs can provide lower starting interest rates compared to fixed-rate loans. However, the interest rate adjusts after the loan’s initial teaser period.

Suppose you are comfortable with changing mortgage interest rates. In that case, ARMs can be an intelligent financial decision.

Scenario 3: Don’t use an ARM if the idea of an ARM makes your worry

ARMs can be an effective money-management tool, but not if it comes at the expense of lost sleep. Don’t use an ARM if adjusting loans worries you. No amount of savings will make up for your discomfort.

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Frequently Asked Questions About ARMs From First-Time Home Buyers

Here is a list of frequently asked questions about adjustable-rate mortgages from our chat and found in online forums.

What Is a “Toxic ARM?”

Between 2005-2008, some mortgage lenders sold ARMs known as Payment Option ARMs. Payment Option ARMs let homeowners choose from monthly payment options for the first five years. Many homeowners chose the least costly option, adding additional principal to the home’s existing loan balance. 

When home values started to drop, a clause in the Option ARM paperwork triggered a reset. Homeowners’ new payments spiked, and large numbers of homes went into foreclosure. 

For the damage they did to the mortgage ecosystem, Payment Option ARMs are now known as Toxic ARMs.

Are ARMs Safe?

Adjustable-rate mortgages are safe when used responsibly. Starting interest rates are lower than fixed-rate mortgages, and interest rate caps prevent rapidly rising payments. 

Are ARMs Better Than Fixed-Rate Mortgages?

ARMs are neither better nor worse than fixed-rate mortgages. ARMs may be right for you if you plan to sell or refinance within five years of purchase or if you like to share the time risk of your loan.

Are Fixed-Rate Mortgages Safer Than ARMs?

Fixed-rate mortgages are not safer than ARMs. The benefit of a fixed-rate mortgage is that you know what your exact mortgage payment will be for the next 30 years. In exchange for that certainty, you’ll pay a higher mortgage rate. Fixed-rate mortgages aren’t safer – they’re more certain. 

Can My ARM Mortgage Rate Go To 20% Overnight?

No, your ARM can’t change overnight or go to 20% because of caps. ARMs can only adjust after the initial starting period ends and on subsequent anniversaries. And, when ARMs adjust, they can only change by a few percentage points at a time.

Can You Refinance an Adjustable-Rate Mortgage?

Homeowners can refinance an ARM or fixed-rate mortgage at any time. However, ARMs don’t constantly adjust higher. Before refinancing your ARM, compare your upcoming adjusted interest rate to today’s mortgage rates. If today’s rates are higher, do not refinance your ARM.

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