An Adjustable-Rate Mortgage (ARM) has an interest rate that changes periodically. The amount of the first change is based on an index. Subsequent changes depend on economic conditions and may create payment increases or decreases during the life of the loan. The ARM note stipulates how often your interest rate and payment will change, as well as the index to be used. The changed rate will be used to calculate your principal and interest payment within the boundaries of any payment rate caps that apply to your loan.
An ARM usually offers a lower initial interest rate than a fixed-rate loan. You may be able to qualify for a larger loan amount with an ARM because the credit decision can be based on current income and the first year's monthly payments, which will most likely be lower.
One disadvantage to an ARM is that an increase in interest rates may cause your monthly principal and interest payments to be higher. It is important to know that with ARMs, your payment, interest rate and Annual Percentage Rate (APR) may increase significantly over time.