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Variable or adjustable loan is loan whose interest rate, and accordingly monthly payments, fluctuate over the period of the loan. With this type of mortgage, periodic adjustments based on changes in a defined index are made to the interest rate. The index for your particular loan is established at the time of application.

Most ARMs have an interest rate caps to protect you from enormous increases in monthly payments. A lifetime cap limits the interest rate increase over the life of the loan. A periodic or adjustment cap limits how much your interest rate can rise at one time. Your mortgage disclosure will tell you the exact index, to be used, whether the weekly or monthly value applies, the lead time for your index, the margin, and any caps.Some types of ARMs offer payment caps, which limit the amount the monthly payment can increase. If a loan has payment cap but has no periodic interest rate cap, then the loan may become negatively amortized: if the interest rate increases and the monthly mortgage payment does not increase sufficiently then the payment does not cover the interest payment, so the loan balance increases. However, you always have the option to pay the minimum monthly payment, or the fully amortized amount due.

With most ARMs, the interest rate can adjust once a year, every three years, or every five years. The interest rate on negatively amortized loans can adjust monthly. 1-year ARM means a loan with an adjustment period of one year.
Some types of ARMs offer an initial lower interest rate than the fully indexed rate (index plus margin) for the first six month, or the first year. It is also known as teaser rate. All ARMs are available with 30-year terms and some with 15-year terms. Adjustable rate mortgages generally have a lower initial interest rate than fixed rate loans.

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