When an Adjustable-Rate Mortgage Can be a Smart Move

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Main takeaways

• Adjustable-rate mortgages start with lower interest rates than fixed-rate loans, but those rates eventually reset—and can rise or fall with market conditions.

• ARMs can make sense if you plan to move within a few years, since you might sell before the rate adjusts.

• Falling interest rates or rising income can make an ARM appealing, but both scenarios carry risk if the future doesn’t go as planned.

• Fixed-rate loans offer predictability, while ARMs trade stability for potential savings—making it crucial to weigh your timeline and tolerance for uncertainty.

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Predictability may not be exciting, but it can often make life easier—especially when it comes to major financial decisions. That’s why the vast majority of Americans have chosen mortgages with a fixed interest rate when purchasing or refinancing a home in recent years. 

But that doesn’t mean adjustable-rate mortgages can’t be a good idea, as long as you understand what you’re getting into. Below we’ll explore some situations where these home loans are something you may want to consider. 

How do adjustable-rate mortgages work? 

A fixed-rate loan is straightforward enough. For as long as you pay down your mortgage—whether that’s, say, 15 years or 30 years—the interest rate you pay doesn’t change. Interest rates can go up or down across the wider economy, and yet you know exactly how much you’ll owe the lender each month.

Adjustable-rate mortgages, or ARMs, are a different animal. You pay a starter interest rate based on your credit worthiness and prevailing rates at the time you take out your loan. Typically, that introductory rate is less than that of a fixed rate mortgage with the same overall duration, which is one the main reasons why these loans are so tempting. 

But after a certain period of time (usually three to 10 years) your rate “resets.” And it continues to adjust at specific intervals. If interest rates have fallen since you received the loan, a reset may result in a lower rate than the one with which you started. But if the opposite is true, you could see an increase—perhaps even a large spike—in the rate your lender charges. 

Can you start with an adjustable-rate mortgage and refinance to a fixed-rate mortgage down the road? Sure. But there are a couple caveats. Interest rates may trend upwards by the time you refinance, potentially forcing you to lock in a rate that’s higher than the one you could get today. In addition, you’ll have to pay closing costs on your new loan, which typically cost 2% to 5% of the amount you borrow. 

Understanding ARM terminology

When shopping for home loans, you’ll probably see terms like “3/1” or “5/6” ARMs. The first number indicates the number of years during which your starter rate is locked in before resetting. The second number is the frequency with which it resets from that point on. A “1” for that second number indicates one year, but a “6” represents a six-month reset. 

So a “3/1 ARM” first resets after three years, and then every year thereafter. And that “5/6 ARM” has an initial reset at five years, and then adjusts every six months.  

When to consider an adjustable-rate mortgage

The attractive starter rate on an adjustable-rate mortgage can be hard to pass up, particularly when you’re working with a tight budget. But there’s always a risk that rolling the dice with an ARM could lead you down the path to regret later on. 

That’s why you should always weigh your options carefully when considering one of these variable-rate loans. Here are a few cases when an ARM is something you may want to at least consider: 

1. You only plan to be in your home for a short time.

The prospect of a rate reset on the horizon can be a scary thought for a homeowner. If you move before the introductory rate adjusts, though, that reset doesn’t come into play. 

In general, the shorter the length of time you stay in your home, the better an adjustable-rate mortgage starts to look. Unless you’re sure that you’ll be moving on within a few years, you may want to play it safe and get a fixed loan. 

2. Interest rates are falling.

If interest rates are expected to drop, a rate reset can actually work to your benefit. Should financial markets move as you anticipate, you could find yourself paying a lower rate than the one you started with.

Even so, you generally shouldn’t make a loan decision based on interest rate assumptions alone. While the Federal Reserve often signals its rate-changing intentions for the months ahead, predicting what will happen a year or more into the future is a fool’s errand. 

3. You expect your income to increase. 

Another situation when taking out an ARM can be a good idea: You’re in the early stages of your career and expect your income to jump in the years ahead. Even if your payments get bigger after the rate resets, you’ll have enough excess income to stay within your budget. In the meantime, you’re benefiting from lower initial payments. 

Of course, no one has a crystal ball, which means there’s a chance that your increased paycheck may never materialize. If you don’t have savings that you can lean back on if necessary, you may want to tread carefully. 

The upshot 

It’s hard not to pass up a lower initial payment that an adjustable-rate mortgage provides. But in order to avoid a financial shock when your loan resets, be sure an ARM makes sense for your situation.