Adjustable Rate Mortgage
Adjustable rate mortgages do what you'd expect - the rate 'adjusts'.
It works like this: With a fixed rate mortgage your monthly payments will be the same over the life of the mortgage. You'll always know what you'll have to pay. In contrast with an adjustable rate mortgage (sometimes called an ARM) your payments will change over time.
The mortgage payment will be 'adjusted' when the interest rate is adjusted. You can expect the interest rate to be adjusted at regular intervals.
Usually, you start with a period of a year at a fixed rate. This rate is often quite low, as an incentive to get an adjustable rate mortgage. Then, after the initial fixed period the interest rate is usually adjusted yearly to reflect the current rates. If the rates go down so do your mortgage payments. But if the rates go up, your payments will go up.
Here's an example: a "3/1 ARM" is fixed at an initial low rate for the first 3 years, and then adjusts every year based on an index. Common adjustable rate mortgages are: 1/1, 3/1, 5/1, 7/1, and 10/1. These adjustable rate mortgages stay fixed for 1, 3, 5, 7 or 10 years and then adjust every year.
In general, if you are interested in an adjustable rate mortgage take a relatively short fixed term - 3 years is likely the best; depending on the interest rate you are offered for the fixed term.
The benefit of ARMs is you have periods of fixed interest and then opportunities to take advantage of current interest rates. If rates go down, you benefit. The problem is that you may find your rate adjusting during periods of rising interest and this can mean higher payments and more money out of your pocket. But these do give you some of the benefits of variable rate mortgages with more stability for those who want to mitigate the risk of a variable rate mortgage.
However, as with all good deals check the fine print. Sometimes, an adjustable rate mortgage can cost you more in the long run, especially after the initial incentive interest rate is replaced by an adjusted rate. Know what you are getting into.