We are still in the frigid grip of winter but the spring home buying season is about to heat up. The most common mortgage is a fixed rate 30-year mortgage. With an adjustable-rate mortgage, or ARM, the interest rate moves up and down along with interest rates in the overall economy. The rate is adjusted periodically, either yearly or with longer intervals. The rate often moves in tandem with the one-year U.S. Treasury bill, or some other similar bond rate.
ARMs usually start with a lower interest rate than a fixed mortgage.
This is because the homeowner with an ARM assumes some of the risk that rates may go up. With a fixed rate mortgage the lender is stuck with the same rate even if interest rates explode during the 30-year term of the loan. With the ARM that risk is shared between the lender and borrower, so the borrower is rewarded with a lower rate at the beginning. A typical ARM has limits on how much it can be adjusted. For example, many ARMs can be adjusted a maximum of 2 percent in any given year, and 6 percent over the life of the loan.