Which loan type allows for an increase in payments when interest rates rise?

An adjustable-rate mortgage (ARM) is designed to allow for changes in payments based on the fluctuations of interest rates. Unlike fixed-rate mortgages, where the interest rate remains constant throughout the loan term, ARMs have an initial fixed period after which the interest rate adjusts periodically, typically tied to an index. When interest rates rise, the payment on an ARM can also increase, reflecting these higher rates.

This characteristic makes ARMs appealing to some borrowers seeking lower initial payments and who may expect stable or declining interest rates in the future. However, it also introduces the risk of higher future payments if rates increase, which can significantly affect monthly budgeting for homeowners.

In contrast, fixed-rate and conventional mortgages maintain consistent payments regardless of market interest rate changes. Subprime mortgages can have varying structures, but they do not inherently allow for a change in payments due to general interest rate adjustments like ARMs do. Therefore, the key trait of adjustable-rate mortgages is their flexibility regarding interest rate changes, which directly influences payment amounts over time.