Also known as a variable rate mortgage, an adjustable rate mortgage is a mortgage whereby the interest rate applied on the outstanding balance varies throughout the life of the loan.

The initial interest rate is fixed for a period of time, after which it resets periodically, often every year or even monthly.

In some countries, banks may publish a prime lending rate which is used as the index. Most lenders tie adjustable rate mortgage interest rate changes to changes in an index rate.

Lenders generally allow borrowers to lower their initial payments if they are willing to assume the risk of interest rate changes.

Many borrowers choose fixed interest rates, while some borrowers choose to have an adjustable rate mortgage because of the possible savings that could be made.

Adjustable rate mortgage pros:

Adjustable rate mortgages can be good options for homebuyers who know they will be in the loan for only a few years. They can benefit from lower payments when interest rates are low.

These loans come with a significantly lower starting interest rate and monthly payment.

As a borrower you can end up saving a lot of money during the initial fixed-rate period.

Some ARMs come with an interest rate cap, which places a limit on how much your interest rate can increase. This way, you won’t have to pay exorbitant amounts should interest rates rise significantly.

Lenders generally allow borrowers to lower their initial payments if they are willing to assume the risk of interest rate changes.

What are the cons of adjustable rate mortgages?

Interest rates move higher after the initial rate period, which means that payments will increase.

The payment shock could result in default, which will have an adverse effect on your credit record.

Some ARMs come with a prepayment penalty.