What characteristic defines an adjustable-rate mortgage (ARM)?

An adjustable-rate mortgage (ARM) is defined by its interest rate, which changes periodically based on an index. This means that the interest rate at which the borrower pays is not fixed; instead, it fluctuates depending on current market conditions and the specific index to which the ARM is tied. Typically, this type of mortgage begins with a lower initial rate than that of a fixed-rate mortgage, offering an attractive option for borrowers who expect their income to increase or who plan to sell or refinance before the adjustments kick in.

The concept relies on the notion that the initial lower rate can significantly reduce monthly payments in the early years of the mortgage, but the rate adjustments can lead to higher payments later on as markets change. Understanding the implications of these periodic rate adjustments is crucial for borrowers, as it impacts their long-term financial planning and the overall affordability of the mortgage.

By recognizing that the interest rate changes based on a specified index, borrowers can better assess their risk and manage their financial commitments effectively.