The introductory rate you pay for the first 

months of an adjustable-rate mortgage is 

almost always lower than the actual cost 

of borrowing the money. What it means  

for the borrower is not only a few months 

of relief but also lower closing costs.  

The effect is to make mortgages more  

accessible to more people.

What it means for the lender is being 

able to adjust the rate upward when the 

introductory period ends, while staying 

competitive with other lenders.



ARMs were introduced in the 

1980s to help more buyers  

qualify for mortgages, and to 

protect lenders by letting them 

pass along higher interest  

costs to borrowers.


An ARM has a variable inter-

est rate: The rate changes on a 

regular schedule—such as once 

a year—to reflect fluctuations 

in the cost of borrowing. Unlike 

fixed-rate mortgages, the total 

cost can’t be figured in advance, 

and monthly payments may rise  

or fall over the term of the loan. 

Lenders determine the new 

rate using two measures: 

  An index, which must be a published 

figure, like the rate on one-year US 

Treasury securities or the cost-of-funds  

indexes. Be sure to check the index. 

Some fluctuate more—and change 

more rapidly—than others

  The margin, a predetermined percent-

age, such as 1.5%, which is added to  

the index to determine the new rate


All ARMs have 

caps, or limits, on the 

amount the interest rate can change. An 

annual cap limits the rate change each 

year, usually to two percentage points, 

while a 

lifetime cap limits the change 

over the life of the loan, typically to five  

or six points.

Be careful: Lifetime caps are based  

on the actual cost and not on the intro-

ductory rate. For example, with a 4% 

teaser rate and a 6.5% actual interest  

cost, your rate could go as high as 12.5% 

with a six-point lifetime cap. 



The size of your  

down payment, your 

employment history  

and earnings record,  

your credit score, and  

the amount you want to  

borrow all affect the  

interest rate you’re offered.  

If that rate is higher than  

the rate the lender is  

advertising, ask for an  

explanation. If you’re not  

convinced, you may want to 

apply to a different lender or 

complain to the Consumer 

Financial Protection Bureau 


if you suspect discrimination.

However, in evaluating whether you’ll 

be able to afford the mortgage, the lender 

must calculate your monthly payment at 

the highest amount it could possibly be 

within the first five years of the term, not 

what that amount would  

be at closing.



Low initial rates (sometimes 


teaser rates

) reduce 

your closing costs and early 

monthly payments


Your interest rate will drop if 

interest rates go down



It’s hard to budget housing 

costs, since monthly payments 

can change at adjustment


Interest costs rise after the 

teaser rate expires


You may have to pay more  

interest if rates go up