Definition
A home loan with a rate that is fixed for a first period and then changes at set intervals based on a market index.
What it means
An adjustable-rate mortgage starts with a fixed rate for an initial period, such as 5, 7 or 10 years, and then adjusts, often every six months or every year. A 5/6 ARM, for example, is fixed for five years and then adjusts every six months. The new rate equals a market index plus a fixed margin, limited by caps on how much it can change at the first adjustment, at each later adjustment and over the life of the loan. The starting rate is often lower than a fixed rate, but payments can rise a lot. Federal rules require lenders to send notices before the first rate change and before payment changes. The Loan Estimate shows the highest possible rate and payment, which helps when comparing an ARM with a fixed loan.
Example
A $300,000 30-year ARM at 6% for five years has a payment of about $1,799. If the rate resets to 8%, the payment on the remaining balance of about $279,000 rises to about $2,155.
Illustrative numbers only. Your situation will differ.