Function

After a fixed introductory period, the interest rate of an ARM loan will vary with market conditions. Usually lenders tie the interest rate to a financial index rate, such as the London Interbank Overnight Rate (LIBOR).

Time Frame

Most ARM loans are listed with two numbers following them. The first number represents the number of years of the introductory period when the interest rate will not change. The second represents how often the interest rate will change.

Considerations

You should consider whether the ARM loan you are taking out has limits on how much the interest rate can change. "Periodic limits" limit how much the interest rate can change each time it fluctuates. "Lifetime limits" set the maximum amount that the interest rate can increase or decrease over the term of the loan.

Benefits

ARM loans will usually offer a lower rate than fixed mortgages. In addition, if mortgage rates fall, you will be able to take advantage of the lower rates without refinancing.

Warning

ARM loan interest rates can increase rapidly. This may make a mortgage that was affordable when it was taken out nearly impossible to pay just a few years later.

Source:

Bankrate.com: Understanding Adjustable-Rate Mortgages

Investopedia.com: Adjustable-Rate Mortgage -- ARM