Adjustable Rate Mortgages (ARM)

An adjustable-rate mortgage keeps one rate for the first few years. After that, it adjusts on a schedule for the rest of the term.

ARMs are named with two numbers. A 7/6 ARM is fixed for seven years, then adjusts every six months. A 5/1 ARM is fixed for five years, then adjusts once a year. The starting rate is usually lower than on a similar fixed-rate loan. That’s the main reason people choose one.

What the rate is built from

After the fixed period, your rate is an index plus a margin. The index is a published market rate that moves on its own. On loans made today it’s almost always SOFR, the Secured Overnight Financing Rate. The margin is a number set when you take the loan, and it never changes.

Rate caps

Three caps limit how much your rate can change. They’re what separate an ARM you can live with from one you can’t.

• The initial cap limits how far the rate can move at the first adjustment.
• The periodic cap limits each adjustment after that.
• The lifetime cap is the ceiling the rate can never go past.

Ask for all three before you compare an ARM to a fixed-rate loan. Then figure out what your payment would be at the lifetime cap. If you could afford that, the loan is a reasonable risk. If you couldn’t, the lower starting rate isn’t saving you money. It’s just putting off the cost.

When an ARM makes sense

Usually when you have a good reason to expect the loan to be gone before the fixed period ends. Maybe you’re planning a move, or a refinance you’re confident about. Betting on where rates will be in seven years isn’t a plan.