An adjustable-rate mortgage (ARM) is considerably different from a fixed-rate mortgage. It may be best if you're buying a home while interest rates are high, if you expect increases in your income, or if you don't plan to keep your home long. Keep in mind, with an ARM, you are taking the risk on the rise or fall of interest rates, not the bank.

In most cases, the initial interest rate of an ARM is lower than a fixed-rate mortgage.

With an ARM, your mortgage rate rises and falls with interest rates. Each lender's interest rates are usually tied to a specific index like COFI, LIBOR, the T-Bill rate, or the CD index. The rate you pay will be based on your lender's index plus a margin, usually two to three points. Ask your lender for specifics. Also ask how the "caps" on your ARM work. "Caps" will limit the amount your lender can increase your interest rate in a single year and over the entire term of the loan.