For many people, buying a home is the single largest financial decision they’ll ever make. Aside from choosing a property that’s the best fit for you, choosing the proper mortgage for you can be just as important. In this article you’ll learn about adjustable rate mortgages (ARMs), to make sure you’re armed with the knowledge you need to get a mortgage that suits you.

What is an ARM?

Mortgages can be broken down into two types. In a fixed rate mortgage the interest rate and the monthly payment both stay the same from month to month.

In an ARM, the interest rate can change periodically, which means the monthly payment will change.

The Index

Typically the interest rate on an ARM is tied to a common index, such as the London InterBank Offered Rate (LIBOR) or the Monthly Treasury Average (MTA). When the index goes up, the interest rate on your mortgage will generally go up, and vice versa.

Margin

The difference between the interest rate on your ARM and the index is known as the margin. If the index increase or decreases, the margin stays the same. It’s important to look at both the index and the margin percentages when looking at an ARM.

Index Rate + Margin = Rate on your ARM

Initial Rate

When you first get an ARM, there’s a discounted rate or the initial rate, that lasts from 1 month to 5 years or more. While the initial rate can make ARMs look more attractive than other loan options, keep in mind that they can adjust to become more expensive.

Adjustment Period

The adjustment period is how often an ARM’s interest rate can change. An adjustment period of 1 year means that the interest rate can change to match the index + margin once a year.

Negative Amortization

When you don’t cover the amount of interest due each month, that amount gets added to the principal, increasing the total amount owed.

Is an ARM right for you?

If you’re only going to stay in your home for a few years, the low introductory rates outweigh the risks of rate increases. But if you’re unsure about that, or don’t like dealing with uncertainty, a ARM might not be for you.