How does an adjustable-rate mortgage function?

An adjustable-rate mortgage (ARM) functions by having an interest rate that changes over time, rather than remaining fixed for the entire term of the loan. Typically, the interest rate is tied to a specific financial index, and as that index fluctuates, so does the mortgage interest rate. This means that the monthly payments can increase or decrease based on changes in the broader market conditions.

Borrowers usually experience an initial fixed period where the interest rate is stable, making monthly payments predictable for that time. After the fixed period ends, the rate adjusts at specified intervals—this could be annually, semi-annually, or at other agreed-upon times. This feature allows for potentially lower initial payments compared to fixed-rate mortgages, but it also introduces the risk of higher payments in the future if interest rates rise.

The other options describe aspects that do not align with how an adjustable-rate mortgage operates. A fixed interest rate throughout the loan term is characteristic of fixed-rate mortgages. Allowing borrowers to change the repayment plan does not specifically relate to adjustable-rate terms. Automatically paying down the principal faster may occur under certain loan conditions but is not inherent to the function of ARMs.