What is an Adjustable Mortgage Loan?

An adjustable mortgage loan (AML), which may also be referred to as an adjustable rate mortgage (ARM), is a type of home or real estate loan where the interest rate varies throughout the duration of the loan, depending on the index upon which it is based. This may include the Constant Maturity Treasury or the Cost of Funds Index, among many others. Each bank may use a different index to determine their interest rates.

To put it simply, an adjustable mortgage loan is a mortgage without a fixed interest rate. Instead, the interest rate is variable, and may increase or decrease over time. Adjustable mortgage loans typically start off with a lower interest rate than a fixed loan, but may end up much higher by the time the loan is paid off. The interest rate at the start of the loan is known as the initial interest rate, and will last for a set adjustment period, typically from one to five years, but it can be any length of time as determined by the bank.

There are many common features to be found on an adjustable mortgage loan, though it is always helpful to shop around at different banks to find the best deals. First, an adjustable mortgage loan will typically have caps placed on it. This means it can only adjust a certain number of times within a set timeframe, and some even feature an interest rate cap, meaning that the interest rate cannot adjust more than a certain percentage at a period of adjustment. Some loans may feature an interest rate cap that sets an interest rate limit for the entire length of the loan, sometimes referred to as a life cap, but this is not common.

An adjustable mortgage loan will typically only adjust once every six months or once a year. To illustrate this concept with an example, consider an adjustable mortgage loan with an initial interest rate of five percent. The loan is scheduled to adjust at one-year intervals but has a two percent interest rate cap on increases; this means that the most the interest rate can adjust to after one year is seven percent. Some banks will instead place caps on the amount the monthly payment can increase; this is a similar concept.

There are various types of adjustable rate mortgages available for consideration by home-buyers. It is important to research all options carefully, and to thoroughly read all loan documents before signing anything. While an adjustable mortgage loan can save money up front, it is important to consider the impact an interest rate adjustment will have on a monthly budget down the road.