Adjustable rate mortgages (ARMs), move with prevailing financial market conditions, with interest rates that reset or "adjust" periodically over the life of the loan. Since these loan are less risky to the lender than fixed rate mortgages, ARMs start at lower "teaser" rates. The lower start rate may be in effect for as little as a month or as long as ten years, depending on the loan terms. Loans with start rates fixed for three to ten years are also called "hybrid ARMs" because they combine the benefit of a low start rate with the stability of a rate that won't change for several years.

Eventually, the teaser rate will reset or adjust to a new rate based on a pre-selected financial index, such as a One Year Treasury rate, plus a margin (generally one to three percent). ARMs also feature periodic caps, which restrict the increase that can be imposed in a single adjustment, life caps, which limit how high a rate can go over the life of the loan, and rate floors, which curb how low they can go, regardless of what happens in the financial markets.

Adjustable rate mortgages offer several advantages. First, there is a lower start rate period during which borrowers save on the higher interest payments on a fixed rate mortgage.

Second, interest rates don't always go up. Where a fixed rate mortgage would need refinancing to take advantage of lower rates, the ARM rate automatically drifts down with the prevailing rates--no refinancing needed. Third, adjustable rate mortgages can save homebuyers money if they only intend to keep the home a short time--and statistics show that the average homeowner keeps a mortgage just five years before refinancing the loan or selling the house.