When you take out a mortgage, you have many options including a fixed-rate or adjustable-rate loan. Many people automatically choose the fixed-rate loan because it’s what they know. In some situations, though, the ARM loan is a great option.

What is an ARM Loan?

An ARM loan or adjustable-rate mortgage is a loan with an interest rate that changes. It has a fixed period (introductory period) where the interest rate remains fixed, and then it adjusts annually according to the index and margin set for the loan.

Let’s say for example you take out a 5/1 ARM. The loan would have a fixed rate for the first five years, which is usually a rate lower than fixed-rate borrowers get. After the fifth year, the rate adjusts annually on the adjustment date.

The rate adjusts according to the chosen index, such as LIBOR, plus the margin, which is a preset number. Let’s say the margin is 1% and the LIBOR is 2.3%. Your rate for the year would be 3.3% (these are hypothetical numbers).

On the next adjustment date, the same thing would happen, the rate would adjust according to the current LIBOR index plus the margin.

Terms to Know

ARM loans have more terms you should know than fixed-rate loans have. Understanding these terms will help you understand the ‘best and worst’ part of the ARM loan.

Adjustment interval – Most ARM loans adjust annually, but don’t assume. Find out the adjustment interval to make sure it’s something you’re comfortable having.