Adjustable-Rate Mortgages ("ARMs") can be an attractive option for borrowers who anticipate moving in three to five year because they tend to offer lower rates at the beginning of the loan.
An ARM will guarantee an introductory rate that is typically lower than that of a fixed rate mortgage for a set period of time. After this time, the rate will "unlock" and adjust periodically to an outside index.
"5/1" is a common type of ARM. Citing our example, the borrower will pay a a lower fixed interest rate for the first five years (the "5" in 5/1). In year six, the rate will adjust once a year (the "1" in 5/1) for the remaining life of the loan.
Many different types of ARMs are available - some adjust once a year and others every six months. Most have "caps" that ensure your monthly payment will not increase too much.
The actual amount of your monthly payment may be capped. Meanwhile, a "lifetime cap" represents the maximum interest rate your loan may reach but never exceed under any circumstance.