Definition
Adjustable-Rate Mortgage (ARM) is a home loan whose interest rate adjusts periodically according to a financial index or market interest rates, causing the borrower’s monthly payment to increase or decrease over time.
Why It Matters
ARMs often start with lower introductory rates than fixed-rate mortgages, reducing initial borrowing costs. However, if market interest rates rise, future payments may increase significantly, making these loans important for understanding household financial risk and housing market dynamics.
Example
A borrower takes out a 30-year mortgage with a 3% introductory rate fixed for five years. After five years, the rate adjusts annually based on market conditions. If rates rise to 5%, the borrower’s monthly payment increases.