An adjustable rate mortgage (ARM) is a mortgage with an interest rate that is variable. Unlike a fixed rate mortgage where the payments are steady throughout the term of the mortgage, interest rates for adjustable rate mortgages are linked to an economic index and tend to vary over a period of time.

Adjustable rate mortgages usually have an initial fixed rate that is lower than the interest rate of a comparable fixed rate mortgage. This is because these kinds of mortgages transfer a part of the interest rate risk from the lender to the borrower.

A lower initial rate means lower payments, which can allow you to take a larger loan. However, if the interest rates start rising, your monthly payments will increase or the term of the mortgage will increase depending upon the policies of your lending institution.

An ARM begins with a rate that is fixed for the initial period. Once this initial period is over, interest rates vary at adjustment intervals. For example, a "3/1 ARM" has a initial low rate that is fixed for the first 3 years, and then gets adjusted every year, based on the variations in the economic index to which it is linked. Common adjustable rate mortgages include: 1/1, 3/1, 5/1, 7/1, and 10/1.

Some adjustable rate mortgages may be allowed to get converted into fixed rate mortgages. However, a conversion fee is levied, which could be high and could take away any savings that you might have gained from the initial lower rate.

Lenders do not allow you to choose the economic index to which the adjustable rate mortgage is linked; however, you can choose the lender based on the index that will apply to your loan.

It is advisable to ask the lender how each index used has performed in the past and choose the index that has remained fairly stable.