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A mortgage whose rate is variably adjusted according to the interest rate environment is known as an ARM.

With an adjustable rate mortgage (ARM) , the interest rate is lower at the beginning than the fixed-rate alternative, but the customer bears the risk of interest rates going up in the future.

The bank or institution creating such a product will usually peg the rate to a specific index or benchmark rate, and will also probably give the customer a cap at which rate hikes would stop.

These are designed to be easy to sell, but may not be in the best interest of the borrower. They usually start with a fix-rate initial period, and then set intervals going forward at which the rate can be adjusted up or down depending on market conditions and prevailing interest rates.

The variable interest rate formula allows the lending institution to give itself some insurance against market and interest rate risk. Fixed-rate loans tend to be better in the long-term, just because there’s no question about how much you’ll be paying, and there will be no surprises.

People often refinance to switch from a variable rate to a fixed rate.

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