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
Pros & Cons
Frequently Asked Questions
How does a 7/6 ARM work?+
A 7/6 ARM has a fixed rate for the first 7 years, then adjusts every 6 months for the rest of the 30-year term. The adjustment is based on an index (typically SOFR) plus a margin set by the lender, subject to caps.
What are the caps on an ARM?+
Most ARMs have three caps: an initial cap limiting the first adjustment (often 2% or 5%), a periodic cap limiting each subsequent adjustment (usually 1% or 2%), and a lifetime cap limiting total rate change (typically 5% or 6% over the start rate).
Is an ARM safer now than it was in 2008?+
Yes. Post-2008 ARMs must be fully underwritten at the higher-payment scenario, so borrowers qualify even if the rate adjusts up. They're a legitimate tool — just understand the reset math before signing.
When does an ARM make sense?+
ARMs make sense when you plan to sell or refinance before the fixed period ends, or when initial rates are significantly lower than 30-year fixed. They're also useful when you expect income to rise (and can absorb future increases) or when you want maximum buying power in the short term.