An adjustable-rate mortgage (ARM) is a home loan where the interest rate changes periodically based on a benchmark index plus a margin set by the lender. ARMs typically start with a lower introductory rate — often called a teaser rate — that remains fixed for an initial period, commonly 3, 5, 7, or 10 years. After this initial period, the rate adjusts at regular intervals (usually annually) based on market conditions. Learn more about when an ARM makes sense.
The naming convention for ARMs reflects their structure: a 5/1 ARM has a fixed rate for the first 5 years, then adjusts every 1 year. A 7/6 ARM is fixed for 7 years, then adjusts every 6 months. During the adjustable period, the new rate is calculated by adding the lender's margin (typically 1.5% to 3.5%) to the current value of the index (commonly the Secured Overnight Financing Rate, or SOFR). For example, if the SOFR is 4.5% and the margin is 2.5%, the adjusted rate would be 7.0%.
ARMs include caps that limit how much the rate can change. The initial adjustment cap limits the first change after the fixed period (typically 2% to 5%). The periodic adjustment cap limits subsequent annual changes (usually 1% to 2%). The lifetime cap limits the total increase over the loan's life (commonly 5% to 6% above the initial rate). These caps protect borrowers from extreme rate spikes, but the rate can still increase substantially over time.
The primary advantage of an ARM is the lower initial rate, which means lower monthly payments during the fixed period. This makes ARMs attractive for buyers who plan to sell or refinance before the rate adjusts, or for those who expect their income to increase. However, if rates rise and the borrower still holds the loan, payments can increase significantly. Use Beycome's mortgage calculator to compare ARM and fixed-rate mortgage payments side by side.
At closing, your closing disclosure will detail the initial rate, adjustment schedule, caps, index, margin, and worst-case payment scenarios. Understanding these terms is critical before signing. At Beycome Title, our settlement team reviews every loan document with you to ensure you understand exactly how your ARM works. Get started with a free closing cost estimate.