An adjustable-rate mortgage (ARM) offers some notable perks, like a low starting interest rate. This kind of home loan isn’t without its risks, though. ARMs can make budgeting harder. If you’re looking for a mortgage, understanding the pros and cons of an ARM can help you decide if this kind of financing is right for you. 

Quick refresher on ARMs

An adjustable-rate mortgage, or ARM, is what it sounds like: a home loan with an interest rate that adjusts. 

Most ARMs are hybrid ARMs, like 5/1 or 7/1 ARMs. With those options, you get a fixed interest rate for the number of years before the slash (5 or 7, respectively), and your rate then adjusts annually (the 1 after the slash). 

The way your rate adjusts depends on two things: the index to which your loan is tied and the margin the lender adds. If your loan is tied to the Secured Overnight Financing Rate (SOFR) and that goes down, for example, your interest rate goes down. 

Be advised, though, that over the long term, the indexes attached to ARMs tend to go up. That means borrowers’ interest rates usually do, too.

Why, then, do people choose an ARM? This type of home loan can offer some perks. 

The pros of an ARM

If you’re drawn to an adjustable-rate mortgage, it’s probably because of one or more of these features: 

A lower introductory interest rate

This is the big pro. The interest rate on an ARM loan almost always starts lower than the rate on a fixed loan. 

The amount of time you get with that fixed introductory interest rate depends on your ARM. Specifically, the number before the slash indicates the length of that introductory period in years. On a 3/1 ARM, it lasts for three years. On a 10/1 ARM, you get a decade with that introductory rate. 

Lots of options

There are plenty of different ARM structures, which can help you choose the right loan for your specific needs. A lot of people pick ARMs when they think they’ll move before the introductory period is up. With common options like 3/1, 5/1, 7/1, and 10/1 ARMs, you can pick the loan with the fixed-rate period that best aligns with your future plans. 

To add even more options into the mix, not all ARMs adjust on an annual basis after the introductory period. Some adjust every six months (e.g., 3/6, 5/6, 7/6, 10/6 ARMs). Because it gives the lender more flexibility to adjust your rate, that more frequent adjustment period usually scores you a slightly lower interest rate. 

On top of all of this, you can get certain ARMs backed by the Federal Housing Administration (FHA) and Department of Veterans Affairs (VA). FHA and VA loans can come with looser eligibility requirements and a low — or, in the case of a VA loan, no — down payment requirement. 

Potential for monthly payment decreases

Your lender has to adjust your rate in line with how your loan’s index moves. If that index goes down, it can mean a lower monthly payment for you — at least until the next rate adjustment.

Indexes tend to trend upward over time. But the economic volatility we’ve seen recently could nudge them downward in the near-term future. 

Protection from excessive rate hikes

Your lender can’t raise your rate too high too fast. ARMs come with caps that limit how much they can raise the rate at each adjustment period, and over the whole life of the loan. That means you can crunch the numbers on your worst-case scenario (i.e., the highest possible monthly payment) to make sure the ARM works for you. 

The cons of an ARM

ARMs come with risks that you should definitely understand before you take out this kind of home loan. Those include: 

Unpredictability

This is the major drawback with an ARM. With a fixed-rate mortgage, you always know how much your monthly payment is going to be. That makes it a whole lot easier to budget.

With an ARM, your payment can go up or down — but you should always plan for upward movement. Even then, though, you don’t know how much more you’ll potentially need to pay. Don’t get too comfy in your introductory period, because rate adjustments will come unless you move or refinance into a fixed loan.

Potential for tougher qualification criteria

Lenders want to make sure you won’t default on (fail to repay) your loan even if your monthly payment goes up. As a result, a lot of them evaluate your ability to make the maximum monthly payment per your ARM’s terms. That can make it trickier to get approved for this kind of loan. 

Complexity

The rate caps we mentioned earlier are just one piece of the puzzle. ARMs often have more complicated rules and fees than fixed-rate loans, which can make them harder to manage for the borrower. 

Additionally, prepaying your ARM can be more complex than prepaying a fixed-rate loan. With the interest rate changing, it’s hard to predict how much any prepayment will save you — if anything at all. Plus, while fixed-rate loans usually don’t have prepayment penalties anymore, your ARM might. 

Is an ARM right for you?

Clearly, there’s a lot to consider here. Using an ARM calculator can help you get a better feel for what this kind of home loan would mean — and if it’s right for you.

If you think it might be, start watching ARM rates. Our continually updated rate tables can help you hone in on the right time to submit your mortgage application. 

Once you start moving forward, make sure you compare offers from at least a few different lenders, specifically looking at their rate caps and the margin they add to their index. This should help you find the best ARM for you. 

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