Adjustable rate mortgages (ARMs) include a variety of different mortgage products designed for different borrower needs.
The most common adjustable rate mortgage is called a 1 year ARM. This program adjusts annually to a new rate determined by the then current market conditions. The rate is calculated by using some index (such as the one-year Treasury bill rate) and adding to it a margin (most often 2.5% to 3.0%). Most programs have caps, or limits, to how much they can change per adjustment and also over the life of the loan. With 1 year ARMS, the caps are commonly 2% per adjustment and 6% over the life of the loan.
1 year ARMs offer the advantage of a low initial rate in exchange for the security of a fixed rate. If the borrower is looking to stay in the home for only a short while, the 1 year ARM is an excellent alternative.
Some ARMs (convertible ARMs) offer a conversion feature that, for a small fee, allow the ARM to convert to a fixed mortgage. When they convert, they are locked into a new rate (prevailing) without having to go through a new qualifying process or refinance. The main drawbacks are that conversions usually must take place between the first and fifth years, and the rate they convert to is somewhat higher than the best rates available at that time. It does, however, allow for some margin of security that a regular 1 year ARM does not. Other common periods for the initial rate of ARMs are: 6 months, 3 years, 5 years, 7 years, and 10 years.
Two-step mortgages are adjustable mortgages that are set at a fixed rate for a predetermined period of time and then adjust once to a new rate for the balance of the term. Some examples of these are the 5/25 and 7/23 two step programs. They offer a lower interest rate than a 30 year fixed rate mortgage, with the 5/25 being lower than the 7/23. A first time home buyer might consider one of these programs if they need a lower rate in order to qualify but anticipate higher future income.

A buydown mortgage is a hybrid between a fixed rate and an adjustable rate mortgage: the loan adjusts to predetermined rates at predetermined periods. For example: a 3-2-1 buydown usually has the first year's interest rate 3% lower than the contract rate, the second year's interest rate 2% lower than the contract rate, and the third year's interest rate 1% lower than the contract rate. The remaining 27 years of the loan are at the contract rate.