Adjustable Rate Mortgage (ARM)
The interest rate on an Adjustable Rate Mortgage will adjust throughout the life of the loan. The rate will change based on a specific market index, such as the 1 Year Treasury or LIBOR, plus a preset margin.
A cap exists on the rate. If you have a 5 point cap, your interest rate can never go up 5 percent more than the interest rate you had at the time of your original closing. Also, the amount that your interest can change each year, either up or down, is typically capped to 1 or 2 percentage.
PRO: The interest rates are typically lower than fixed rate loans. Since the interest rates are lower, the payments are also initially lower so you can be eligible for a higher loan amount.
CON: Variable interest rates result in variable payments.