How It Works
An Adjustable-Rate Mortgage (ARM) starts with a fixed interest rate for an initial period, then adjusts periodically based on a market index plus a margin set by the lender. The most common ARM products are the 5/1, 7/1, and 10/1 ARM, where the first number represents the years of the fixed-rate period and the second represents how often the rate adjusts after that.
During the initial fixed period, ARM rates are typically lower than comparable fixed-rate mortgage rates, resulting in lower monthly payments. After the initial period, the rate adjusts based on a benchmark index (such as SOFR) plus a set margin. Rate caps limit how much the rate can change per adjustment period and over the life of the loan, providing some predictability.
ARMs make the most sense for borrowers who plan to sell or refinance before the initial fixed period ends. They are also popular for buyers who expect their income to increase or who are purchasing in a market where they may relocate within a few years. Understanding the rate caps, adjustment intervals, and worst-case payment scenarios is essential before choosing an ARM.
Who Is This For?
- Homebuyers who plan to sell within 5-10 years
- Borrowers who expect to refinance before the rate adjusts
- Buyers who want lower initial monthly payments
- Those who expect rising income to cover potential rate increases
- Purchasers in markets where they may relocate for career or family reasons