An Adjustable Rate Mortgage (ARM) is a mortgage loan with an interest rate that changes, usually several times, over the term of the loan. The interest rate typically starts out at a “below-market rate” to provide a lower monthly payment for the first year or two, then slowly begins to move up to a rate that is typically above the market rate. This is how the rate “adjusts” from low to high to average an interest rate that would approximate a fixed rate. The idea being that as your income increases over the years it will keep up with the increasing rate adjustments, allowing you to buy a more expensive home now rather than waiting for the increased income level.
An ARM is a different loan product than a fixed-rate loan, obviously. A fixed-rate mortgage loan carries the same interest rate throughout its term. A hybrid ARM is a combination of an adjustable rate mortgage loan and a fixed-rate mortgage loan. They typically allow for a fixed rate for a period of time and then adjust upward, or vice versa: they allow for an adjustable rate for the first three to five years, then stay fixed for the remainder of the term. Often, the rate adjustment is “capped”, which means it can’t go up more than a set amount during the adjustable rate period. For example, a 5/1 adjustable rate mortgage loan is one that can go up no more than one percent per year for the first five years, then the rate becomes fixed. There are variations of this, but a 3/1 and a 5/1 are the most common.