Adjustable-Rate Loans: When to Use and When Not to Use This Loan Option

Those in the business of making loans, whether it be as a private lender, bank, or other entity, along with those dealing with such loans, such as mortgage brokers, real estate brokers, real estate attorneys, and many other folks should be very aware of what an “adjustable rate loan” or, as they are often labeled, an adjustable rate mortgage (ARM) means.

The interest rate stated in the loan can be adjusted, that is, increased or decreased, depending on the terms of the ARM.

Many experts in this loan field have often commented that an ARM is of great benefit to a borrower—in some cases—because the rate can be reduced. However, what many borrowers, under an ARM, are now learning is that such “adjustment” of the interest rate, can go up or down in many loan documents.

That is, the change in the rate under the ARM is not normally a one way street in almost all cases. Clearly, the borrower, who might have borrowed at say an 8% rate, would favor reducing the rate, especially if there is a substantial adjustment to the lower side, such as to a 5% rate. This 3% in this example, on a debt owing of $100,00, would save an annual amount of 3% of $100,000, viz. 3,000—or what would be $250 per month!

However, if the ARM allows the lender to increase the interest rate being charged where rates have moved up, the lender is just as eager as the borrower in the prior example to make the adjustment. If we flip the setting where the loan is $100,000, but the interest rate stated for the borrower is 5% annually, with a potential increase to 8%, this same 3% change as noted earlier will now, with such change, burden the borrower with an additional payment of $250 per month.

The above examples are fundamentally clear for most folks. Yet, many borrowers, when they financed the purchase of their house, elected to undertake an ARM, even when the existing rate was low at the time the loan was originated.

Why?!

It appears in this setting that the borrower did not receive good advice. A fixed rate loan, where the lender could not increase the rate, such as the examples above, by 3% points, clearly illustrates why the fixed rate would have been the more intelligent choice as to the type of loan undertaken by the borrower.

Yes, hindsight is 20-20 as it is said. However, the likelihood of the interest rate moving lower from a 5% loan is slight, compared to the possibility that the rate will be increased. It is true that only a few years ago there were residential loans being made at a rate lower than the stated 5%. Some of those loans were in the range of 2.5% to 3%. However, as many borrowers are learning, today, such lower rates are a rarity in history in the last 20 years.

Recent reports have shown that as to those who took out an ARM in the last 5 years, they will often be facing a substantially higher monthly payment when the interest rate increase becomes applicable.

In a recent article in the Wall St Journal of 10/28/2026, the article, citing loan sources, noted:

“According to Intercontinental Exchange, 186,000 adjustable-rate mortgages readjust next year, increasing the monthly payment initially by a median $645, which will eventually turn into $754 after getting through rate increase caps baked into the loans.

The largest category consists of people who took out seven-year fixed-period adjustable rate mortgages in 2020. They face a median monthly payment increase of 43%, or $1,269 a month.”

Thus, with close to 200,000 loans being adjusted by increasing the interest payments, many borrowers will find this extra financing burden very difficult to overcome.

The moral of the story: The ARM can be a big benefit, especially when borrowing at a higher rate, with interest rates expected to be reduced in the near future. However, as seen by many borrowers, as noted above, the ARM interest rate can also move up!

Tip by Dr. Mark Lee Levine, Professor, University of Denver