Adjustable rate mortgage (ARM) is a type of mortgage whose interest changes over time. In contrast, fixed rate mortgages made for 15, 20, or 30 years have a set amount of interest on the loan that does not change. ARMs come in many different forms. The typical ARM has a fixed interest rate for a specific amount of time. Then the interest rate changes according to the adjustment frequency. The difference of time between the fixed rate and adjustable rate periods are often expressed over one another. For example, a 5/5 ARM means the mortgage has a fixed interest rate for five years, then adjusts every five years. The amount of interest usually changes based upon a certain benchmark rate such as for certificates of deposit or the Secured Overnight Financing Rate (SOFR). The new interest rate will be the benchmark plus an agreed upon margin. For example, if the mortgage reaches an adjustment where the benchmark is at 5% and a margin of 1%, the new interest rate will be 6% until the next adjustment. Often, parties agree to a maximum amount the interest rate can increase every period (cap) or over the entire life of the loan (ceiling). Many people choose ARMs because they at least in the beginning charge less interest than a fixed-rate mortgage. However, ARMs typically are only for a period of months to a maximum of ten years. As time passes, the ARM may become more expensive than a fixed rate mortgage.
[Last updated in December of 2021 by the Wex Definitions Team]