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Adjustable-Rate Mortgage (ARM)
Definition
An adjustable-rate mortgage (ARM) is a home loan with an interest rate that changes periodically based on a benchmark index.
Explanation
ARMs typically offer a lower initial rate than fixed-rate mortgages for a set period (e.g., 5, 7, or 10 years), after which the rate adjusts annually. Rate adjustments are capped per adjustment period and over the loan's lifetime.
ARMs can save money if you plan to sell or refinance before the adjustment period begins. However, they carry the risk of significantly higher payments if rates rise.
Example
A 7/1 ARM has a fixed 5% rate for 7 years on a $300,000 loan ($1,610/month), then adjusts annually based on the SOFR index plus a margin.