What Is An ARM?
Is It Right for You?
An ARM is an adjustable-rate mortgage loan with a fixed interest rate for the first few years, typically, 3, 5, 7 and 10 years. Afterward, the ARM switches to an adjustable interest rate for the remainder of its term —often called the teaser rate because it’s lower than a fixed-rate mortgage. Once the fixed-rate portion of the term is over, the ARM adjusts up or down based on current market rates, subject to caps governing how much the rate can go up in any particular adjustment — typically once per year. Each time your interest rate changes, your payment is recalculated so that your loan is paid off by the end of your term — usually a 30-year, but it doesn't have to be.
When the rate adjusts, the new rate is calculated by adding an index number to a margin specified in your mortgage documentation. Common indexes used to figure out rates for ARMs include the Secured Overnight Financing Rate (SOFR), the Cost of Funds Index (COFI), and the Constant Maturity Treasuries (CMT)
Understanding Adjustable-Rate Mortgages
What Do All the Numbers Mean?
5/1 ARM
First Number Represents the Number of Years Before the Rate Adjusts
Second Number Represents How Often It Will Adjust
In This Case, One Time Per Year
WITH
2/2/5 caps
INITIAL CAP
In this case, regardless of market conditions, the first adjustment can’t be increased more than 2%.
2
SUBSEQUENT CAPS
In our example above, with each adjustment after the first one, the rate can’t go up more than 2%.
2
5
LIFETIME CAP
Regardless of market conditions, this interest rate can’t go up more than 5% for as long as you have the loan.