How does an "adjustable-rate mortgage (ARM)" function?

An adjustable-rate mortgage (ARM) operates with an interest rate that can change after a specified initial fixed-rate period. This adjustable feature means that the interest rate is tied to a specific financial index, and it fluctuates based on the movements of that index, which is influenced by market conditions.

Typically, ARMs begin with a lower, fixed interest rate for an introductory period—often ranging from 3 to 10 years. After this period ends, the interest rate is adjusted at predetermined intervals, such as annually, every six months, or some other frequency determined by the loan terms. As a result, borrowers may experience lower initial payments during the fixed-rate period, but their payments can increase or decrease in future periods, depending on market rates.

While other choices suggest characteristics that apply to fixed-rate mortgages or misconceptions about ARMs, they do not reflect how ARMs truly function. An ARM is distinct precisely because of its variability in interest rates after the initial fixed term, making it an appealing option for some borrowers who anticipate favorable market conditions over time.