Adjustable Rate Mortgages (ARM)'s interest rates can vary during the loan's term. ARM loans usually have a fixed interest rate for an initial period of time and then adjust based on current market conditions. Adjustable rate mortgages are normally amortized over a period of 30 years with the initial rate being fixed for anywhere from 1 month to 10 years.

ARM loans have a "margin" plus an "index." Margins on loans range from 1.75% to 3.5% depending on the index and the amount financed in relation to the property value. The index is the financial instrument that the ARM loan is tied to such as: 1-Year Treasury Security, LIBOR (London Interbank Offered Rate), Prime, 6-Month Certificate of Deposit (CD) and the 11th District Cost of Funds (COFI).

When an ARM loan adjusts, the margin is added to the index and typically rounded to the nearest 1/8 of one percent to arrive at the new interest rate. That rate is then fixed for the next adjustment period. Adjustments can occur every year, but there are factors limiting how much the rates can adjust. The factors are called "caps". Example: a "3/1 ARM" with an initial cap of 2%, a lifetime cap of 6%, and initial interest rate of 6.25%. The highest rate it could have in the fourth year would be 8.25%, and the highest rate for the life of the loan would be 12.25%.

Some ARM loans have a conversion feature that allows the borrower to convert the loan from an adjustable rate to a fixed rate. There is usually a minimal charge to convert; however, the conversion rate is usually slightly higher than the market rate that the lender could provide you at that time by refinancing.