Everything You Want to Know About Adjustable-Rate Mortgages

An adjustable-rate mortgage (ARM) can be a smart option if you want a lower interest rate for the first few years of your home loan. This guide explains how ARMs work, their benefits, and how they can offer early savings with the eventual opportunity to benefit from favorable market movement.

When exploring a home loan, there's a lot to consider. While it’s tempting to follow the mortgage path friends or family have taken, the best choice is the one that aligns with your plans.

One of the first decisions you’ll consider is the type of mortgage you want. While fixed-rate loans are known for their predictability, adjustable-rate mortgages (ARMs) typically offer lower initial interest rates. For certain borrowers, an ARM could be the more practical choice.

In this guide, we’ll break down how ARMs work, the benefits they can offer, who they may suit best, and a few important considerations to keep in mind.

What Is an Adjustable-Rate Mortgage (ARM)?

An adjustable-rate mortgage (ARM) is a type of home loan that starts with a fixed interest rate for an initial period, followed by periodic rate adjustments. Your rate and monthly payment can change over time based on market conditions, however most modern-day ARMs include safeguards to help manage those changes.

For homebuyers who plan to move or refinance within a few years, an ARM can be a strategic way to save money early on. With the right timing, an ARM can support your short- to mid-term plans.

How Does an ARM Work?

An adjustable-rate mortgage balances lower starting costs with long-term flexibility. Here’s a breakdown of how it works:

Start With a Fixed Rate

Every ARM starts with a fixed-rate period — typically five, seven, or 10 years — during which your interest rate remains consistent. That fixed period often comes with a lower rate than a traditional fixed-rate mortgage.

Transition to an Adjustable Rate

Once the fixed period of your loan ends, it moves into the adjustable phase.

Each ARM product is tied to a specific market index that helps set the initial interest rate and will determine the future rate once the loan moves into the adjustment period. At this stage, the new interest rate will be determined based on the assigned index, plus a set margin. From this point on, your interest rate resets on a regular schedule — typically every six or 12 months — with the extent of adjustment based on the movement of the market index. Depending on economic trends, your monthly payment may go up or down at each reset during this period.

Protect Against Rate Spikes With Built-in Limits

ARMs include built-in limits on how much your rate can increase at the first adjustment, at each subsequent adjustment, and over the life of the loan. These caps help prevent large or unexpected jumps in your payment.

For example, a 5/6 ARM with 2/1/5 caps means your rate can adjust by no more than 2% at the first reset, 1% at each adjustment after that, and never more than 5% above or below the original rate.

At the same time, if market rates stay low, your ARM may adjust downward or hold steady, which could mean lower principal payments and added savings.

You’ll know your ARM’s rate caps before closing on the mortgage Lenders are required to clearly outline the cap structure and other loan details in their Loan Estimate and Closing Disclosure documents.

What the ARM Numbers Mean

If you’ve ever looked at an ARM and thought, “What do these numbers even mean?” you’re not alone. The good news is it’s easier to understand than it looks. Here’s how to read an example like 5/6 ARM with 2/1/5 caps:

• 5 = The number of years your rate stays fixed at the beginning of the loan

• 6 = How often (in months) your rate can adjust after the fixed period ends

• 2 = The maximum rate change at the first adjustment

• 1 = The maximum rate change at each future adjustment

• 5 = The most your rate can go up or down over the entire life of the loan

This works the same way for other ARM types, too. Whether it's a 7/6, 10/6 or another ARM loan, the numbers follow the same pattern to help you understand how your loan may adjust over time.

Breaking Down the ARM: What the Numbers Mean for Your Rate

Using a 5/6 ARM as an example, let’s take a closer look at what the numbers mean and how they impact your interest rate and monthly costs.

What Factors Influence ARM Rates?

Understanding what can influence your ARM rate can help you anticipate changes and choose the right loan for your needs. The following are the main factors that can impact how your rate is set and adjusted:

• Index: The index is a benchmark that tracks the current average interest rate in the financial market at any given time. Your ARM follows an established index once the fixed period ends. Many adjustable-rate home loans today are based on the SOFR Index Averages (New York Fed). Other common indexes include:

  • Monthly Treasury Average (MTA)

  • Constant Maturity Treasury (CMT)

  • Cost of Funds Index (COFI)

  • The Prime Rate

• Margin: The margin is a fixed percentage added to the index to determine your new rate after adjustments begin. Your lender sets the margin.

• Caps: Caps are built-in limits that control how much your interest rate or monthly payment can increase or decrease during each adjustment and over the life of the loan.

• Economic conditions: Market trends, inflation, and Federal Reserve decisions can influence the index and, in turn, your loan rate.

• Introductory period length: This is the initial fixed-rate term of your loan. Typically, the shorter the period, the lower the starting rate.

Types of ARMs

Not all adjustable-rate mortgages are the same. Depending on your financial goals, you can choose a structure that works with your timeline, payment preferences and future plans.

Hybrid ARMs

Hybrid ARMs are a popular choice for homebuyers who want flexibility and a lower rate up front. These can be a good option if you don’t plan to stay in your home long term or are simply looking to take advantage of a lower rate and payment for cash flow purposes. Common hybrid ARMs include:

• 10/6 ARM: 10 years of steady, fixed payments before the rate adjusts biannually.

• 7/6 ARM: Low, fixed rate for the first seven years. After that, the rate adjusts biannually.

• 5/6 ARM: After five years of predictable payments upfront, adjustments kick in biannually.

Interest-Only ARMs

With an interest-only ARM, your initial monthly payments cover just the interest. This keeps costs lower during the intro period. Once that phase ends, you’ll start paying both principal and interest, so it’s important to plan ahead. This option can offer breathing room early in the loan while you get settled or grow your income.

Conventional vs. Government-Backed ARMs

Adjustable-rate mortgages come in as many varieties as fixed-rate home loans, and that includes conventional as well as loans guaranteed by the government, such as those ensured by the Department of Veterans Affairs (VA loans) and the Federal Housing Administration (FHA loans). The structures of each ARM program will differ between those two main categories of government-backed versus conventional loans. For example, Pennymac’s conventional ARM today is offered with either a 5, 7 or 10 year introductory period that subsequently adjusts every 6 months (10/6, 7/6 and ⅚) based on the SOFR index, with caps of 2/1/5. You may also want to opt for our very popular 5/1 FHA and VA ARMs, which are based on the CMT index, come with a 5-year intro period that adjusts once a year in the second phase, and have caps of 1/1/5.

Conforming vs. Nonconforming ARMs

While exploring ARM types, you may also come across terms like “conforming” and “nonconforming.” These labels aren’t exclusive to ARMs — they apply to most home loans. The distinction depends on whether the loan meets Fannie Mae and Freddie Mac guidelines, like loan size limits and borrower requirements.

A conforming ARM loan meets requirements set by Fannie Mae and Freddie Mac. This includes staying below the annual loan limit set by the Federal Housing Finance Agency (FHFA), which is periodically updated. The 2025 limit for a single-family home is $806,500, with high-cost areas capped at $1,209,750.

A nonconforming ARM loan is a home loan that doesn’t meet Fannie Mae or Freddie Mac standards. Most often, it’s because the loan amount is above the conforming limit, which would fall into the classification of a Jumbo ARM. Like other ARMs, these loans feature a low fixed rate for an initial period (such as five, seven or 10 years). Afterwards, the rate adjusts periodically based on a benchmark index.

Nonconforming ARMs typically have higher loan amounts, stricter qualification requirements and larger minimum down payments than conforming ARMs.

ARM Advantages and Things to Consider

Like any mortgage option, ARMs come with their own set of advantages and potential drawbacks. If you're weighing whether this loan structure fits your goals, here’s a look at some considerations.

Advantages of ARMs

• Lower initial rate: ARMs typically start with a lower interest rate than fixed-rate loans, helping you lock in lower monthly payments during the intro period.

• Short-term savings: This loan may be ideal if you’re planning to move, sell or refinance within five to ten years, before the rate adjusts.

• Budget flexibility: A lower initial payment may help you afford a more expensive home or free up funds for renovations, savings or other financial goals.

• No prepayment penalties: Many lenders, including Pennymac, don’t charge a fee if you choose to make additional principal payments at any time or pay off your loan early.

• Extra principal payments really pay off: Unlike a fixed-rate loan, an ARM is recalculated based on the remaining balance when the second phase begins. This means that if you are able to make extra principal payments during the fixed phase, you can significantly reduce your lifetime cost of the loan.

• Refinance options: As long as you remain eligible, you can always refinance your ARM into a fixed-rate mortgage. In fact, Pennymac lets you switch to a fixed-rate loan with the option to keep your remaining term. That means you won’t have to restart your mortgage clock back to 30 years just because you refinanced your loan. That said, there can be advantages to extending your term back to 30 years, such as an even lower monthly payment, which you could find to be helpful under the right circumstances.

• Potential to save long term: If market rates remain steady or drop, your rate could drop as well, keeping payments manageable.

Important Considerations

• Possible rate and payment increases: Once the intro period ends, it’s possible for your rate to increase within the interest rate caps provided based on market conditions, which would impact your payment as well.

• Less long-term predictability: Since your rate can adjust after the fixed period, your monthly payment may rise or fall over time. This variability means an ARM may not offer the steady payment schedule some homeowners prefer for long-term budgeting.

• More financial planning required: ARMs can be a good financial move, but you should plan ahead, especially if you expect rate hikes.

• Qualification considerations: Lenders may assess your ability to pay at the highest possible rate, which could affect how much you qualify to borrow.

ARM vs. Fixed-Rate Mortgage

A fixed-rate mortgage keeps the same interest rate and monthly payment for the entire term (usually 15 or 30 years), offering budget-friendly consistency. ARMs offer a lower initial rate with potential for rate increases or decreases over time, making monthly payments somewhat unpredictable in the long run but potentially less expensive up front.

Qualifying for an ARM

Qualification criteria for ARMs are similar to fixed-rate loans. Lenders will review your credit score, income, debt-to-income ratio (DTI), down payment and assets before approving you for a loan.

And depending on which ARM product you are applying for, the lender may base the approval on the loan’s “note rate,” which in this case will be the fixed rate during the introductory period. They may also consider the “fully indexed rate” on the loan, which is the index rate plus the margin established for the loan. Essentially, they have to make sure you will be able to comfortably manage the monthly payments even if rates go up during the second phase.

Refinancing an ARM

Many homeowners choose an ARM for its initial low rate, with the plan to refinance down the road to adapt to new financial circumstances or priorities. Homeowners with ARMs often refinance in order to:

• Switch to a fixed-rate mortgage, especially at the end of an ARM’s intro period

• Obtain a loan with more predictable terms

• Remove mortgage insurance if your home has gained enough equity (in the case of an FHA ARM)

• Access cash through a cash-out refinance for renovations, debt consolidation or other major expenses

When Might an ARM Make Sense?

While many mortgage shoppers opt for a fixed-rate loan, an adjustable-rate mortgage can be a very attractive option if:

• You don’t plan to stay long term. If you anticipate moving, selling or paying off your home in the next five to ten years, you could benefit from the lower fixed rate during the intro period without ever reaching the adjustment phase.

• You’re planning to refinance. If you think you’ll refinance to a fixed-rate mortgage at some point, an ARM gives you time to save with a lower rate before locking into long-term stability.

• You want more buying power up front. Paying less each month at the start may make it easier to buy the home you want while still setting aside funds for other expenses.

• You’re comfortable with rate movement. ARMs include built-in limits to protect against large jumps, but they still adjust over time. If you're okay with some variability, you might come out ahead.

• You expect your income to grow. If your financial picture is likely to improve over time, beginning with a lower payment can help you get started comfortably and leave the door open for refinancing later.

FAQs About Adjustable-Rate Mortgages

Will my ARM rate always go up after the fixed period?

No, your ARM rate may go up, down, or stay the same after the fixed period. The new rate is based on a market index plus a set margin, so it follows broader interest rate movements. ARMs also have caps that limit how much your rate can adjust at any one time or over the life of the loan.

Can I refinance an ARM?

Yes, you can refinance an ARM at any time, including during the fixed period. Many borrowers refinance into a fixed-rate mortgage, especially if they want stability or anticipate rising rates. Pennymac does not charge prepayment penalties or restrict refinancing out of an ARM.

How often can my rate adjust?

After the fixed-rate period ends, most ARMs adjust at regular intervals, commonly every six or 12 months. The specific adjustment schedule depends on the loan’s terms, such as a 5/6 or 7/6 ARM, where the rate adjusts every six months after the initial period. Always check your loan agreement for the exact timing.

What does the “5/1” or “7/1” in an ARM mean?

The first number is the length in years of the initial fixed-rate period. The second number is how often the rate adjusts afterward — so, for a 5/1 ARM, the rate is fixed for five years and then adjusts once per year thereafter. For a 5/6 or 7/6 ARM, the rate adjusts every six months after the fixed period.

Are ARMs available for all types of homes?

ARMs are generally available for primary residences, second homes, condominiums and investment properties, depending on the specific program.

Is an ARM a good choice for first-time homebuyers?

An ARM can be a good fit for first-time buyers who expect to move, sell or refinance before the fixed period ends, as it offers lower initial rates. However, it may not be ideal if long-term rate stability is a priority.

What happens if I sell my home during the fixed period?

If you sell your home during the fixed period, your ARM loan is paid off with the proceeds, and you incur no rate adjustments or penalties for selling early.

Does an ARM Make Sense For You?

If you want to take advantage of a lower upfront rate and are prepared for potential rate shifts, an ARM may be worth considering. Not sure? A Pennymac Loan Expert can walk you through the possibilities, help you explore your mortgage options, and find the loan that best aligns with your budget and homeownership goals.

Refinancing your existing loan may result in your total finance charges being higher over the life of your loan.