Definition
Adjustable-rate mortgage (ARM)
An adjustable-rate mortgage (ARM) is a home loan whose interest rate is fixed for an initial period and then resets at regular intervals based on a market index plus a set margin, within limits called rate caps. ARMs usually start with a lower rate than a comparable fixed-rate mortgage.
ARM names describe their structure. A 5/1 ARM is fixed for five years and then adjusts once a year; a 7/6 ARM is fixed for seven years and then adjusts every six months. At each adjustment, the new rate is the current index value plus the margin, limited by the caps.
Worked example. A borrower takes a $400,000 30-year ARM at an illustrative 5.75% for the first five years, for a principal and interest payment of about $2,334. After five years, the balance is roughly $371,000. If the index plus margin then works out to 7.25%, the payment on the remaining 25 years rises to about $2,682, a jump of nearly $350 a month. If rates fall instead, the payment can drop, subject to any floor.
ARMs suit borrowers who expect to sell, refinance or see income rise before the first adjustment, and who can absorb a higher payment if plans change. The risk is payment shock. Lenders often qualify ARM borrowers at a rate above the start rate for that reason. Interest-only ARMs and option ARMs add further complexity. The ARM calculator models the payment before and after the first adjustment.
Calculators that use this term
FAQ · 2 questions
Questions about Adjustable-rate mortgage (ARM)
What does 5/1 mean on an ARM?
The first number is the fixed period in years; the second is how often the rate adjusts afterward, here once a year. A 5/6 ARM adjusts every six months after year five.
Can an ARM payment go down?
Yes. If the index falls, the rate and payment can drop at the next adjustment, though many ARMs have a floor, often the margin, below which the rate cannot go.
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