An adjustable-rate mortgage (ARM) is a home loan where the interest rate is fixed for an initial period (typically 5, 7, or 10 years) and then adjusts periodically based on market conditions.
ARMs typically start with a lower rate than a comparable 30-year fixed, which means lower initial monthly payments. The risk is that your rate and payment can increase after the fixed period ends. ARMs make sense if you plan to sell or refinance before the adjustment period begins.
How ARMs Work
The loan has two phases: the initial fixed-rate period (5/1, 7/1, or 10/1) and the adjustment period. During the fixed period, your rate and payment do not change. After that, the rate adjusts annually based on an index (usually SOFR) plus a margin set by the lender. Most ARMs have caps that limit how much the rate can adjust per year and over the life of the loan.
Common ARM Types
- 5/1 ARM: fixed for 5 years, adjusts annually after
- 7/1 ARM: fixed for 7 years, adjusts annually after
- 10/1 ARM: fixed for 10 years, adjusts annually after
- 5/6 ARM: fixed for 5 years, adjusts every 6 months after
The first number is the fixed period; the second is how often it adjusts.
ARM vs Fixed Rate: The Trade-Off
- ARM: lower initial rate (often 0.5-1% below 30-year fixed), lower initial payment, but risk of higher payments later
- Fixed: higher initial rate, higher initial payment, but payment never changes
An ARM is a bet that rates will not spike or that you will sell or refinance before they adjust.
When an ARM Makes Sense
- You plan to sell within 5-7 years
- You plan to refinance before the adjustment period
- You need the lower initial payment to qualify
- You are buying in a high-rate environment and expect rates to drop
When a Fixed Rate Is Better
- You plan to stay in the home long-term (7+ years)
- You want payment certainty
- You are risk-averse
- Current fixed rates are already low
ARM Caps and Safety Features
ARMs include built-in protections to prevent catastrophic payment increases:
- Periodic cap: maximum the rate can increase at each adjustment (typically 2%)
- Lifetime cap: maximum the rate can ever reach (typically 5-6% above the initial rate)
These caps protect you from extreme increases but do not prevent your payment from rising significantly.
Real ARM Example
Here is how a $350,000 loan compares with a 5/1 ARM versus a 30-year fixed rate:
- Loan amount:$350,000
- 5/1 ARM rate:5.75%
- 30-year fixed rate:6.50%
- ARM initial payment:$2,043/month
- Fixed payment:$2,212/month
- Monthly savings with ARM:$169/month
- Total savings over 5 years:$10,140
The risk: if rates are at 7.75% after 5 years, the ARM adjusts to roughly 7.75% with the payment climbing to around $2,480/month.