Compared to fixed-rate loans, the lower cost and interest rate of an ARM (Adjustable-rate Mortgage) makes them more appealing than fixed-rate loans for several reasons:

• no matter what your credit history looks like, a lower rate means that you’re more likely to qualify for the loan.
• lower interest rates mean lower monthly payments
• lower interest rates mean that you can get more home for the same money

The “blessing or curse” of an ARM is vividly demonstrated with what is known as a teaser, or introductory rate. This is the time when you get the lowest-possible interest rate. Depending on the period of this teaser (which can be anywhere from one month to an entire decade!), you’re virtually assured of paying less than the fixed-rate loans.

• However, there are some drawbacks. You may be paying less because less (or even none!) is going to the principal, and all you are doing is paying interest (basically, you’re paying rent on your own home).
• You may be paying less because the interest is deferred, which means that you still owe it, but the lender doesn’t expect you to pay it back just yet. This may cause “negative amortization“, where you’re actually increasing rather than decreasing the amount that you have left to pay!
• The loans that are most prone to this are called Option ARMs, and they may also have a feature called a recast trigger which bumps up the payment BEFORE the scheduled recast (a.k.a. payment adjustment, or reset) — which can cause a very unpleasant “payment shock” to the borrower.
• In the case of Interest-Only ARMs, the opposite is true: you pay only interest during the teaser, and only begin to pay off the principal once the ‘real’ rate kicks in — so you don’t build equity, AND you get hit with a big sudden increase (which you probably should have been expecting, but still…).