An adjustable-rate mortgage (ARM), also known as a variable-rate mortgage or tracker mortgage, is a type of mortgage loan where the interest rate on the note periodically adjusts based on an index that reflects the cost to the lender of borrowing on the credit markets. ARMs typically have a lower initial interest rate than fixed-rate mortgages, making them a good option if you want to get the lowest possible mortgage rate starting out. However, after the initial period, your monthly payment can fluctuate periodically, making it difficult to factor into your budget. ARMs generally permit borrowers to lower their initial payments if they are willing to assume the risk of interest rate changes.

ARMs have four components: an index, a margin, an interest rate cap structure, and an initial interest rate period. When the initial interest rate period has expired, the new interest rate is calculated by adding a margin to the index. As the index figure moves up or down, your interest rate will be adjusted accordingly. Hybrid ARMs offer an initial interest rate that is constant for the first 3-, 5-, 7-, or 10 years, after which the interest rate will adjust annually.

ARMs are generally better for borrowers who plan to stay in the home for a shorter time, or who expect to refinance before the introductory rate period ends. If you’re moving to a place you don’t anticipate being in more than 5 years and are looking for the lowest interest rate on a mortgage, an ARM may be the best mortgage option for you. However, the biggest risk of taking out an adjustable-rate mortgage is the probability that your interest rate will likely increase, which can cause your monthly mortgage payments to go up. If you’re not buying your forever home, then buying a house with an ARM and selling it before the fixed-rate period ends can mean a lower mortgage payment.