An adjustable-rate mortgage gives you a discounted fixed rate for the first few years, after which the rate resets periodically against a market index. The initial saving is real; so is the risk that the payment climbs sharply once the fixed period ends.
Reading the name: 5/1, 7/6, 10/1
The first number is how many years the initial rate is fixed. The second is how often it adjusts afterwards — 1 means annually, 6 means every six months.
A 5/1 ARM is fixed for five years and then adjusts once a year for the remaining twenty-five. A 7/6 ARM is fixed for seven years and then adjusts twice a year.
Index plus margin
After the fixed period your rate is not set by the lender's discretion. It equals a published index plus a fixed margin written into your note.
The margin never changes for the life of the loan — it is the lender's spread, typically 2% to 3%. The index moves with the market; most US ARMs now track SOFR, having moved away from LIBOR.
Index plus margin is called the fully indexed rate. If it is already above your teaser rate on day one — which is common — your payment will rise at the first reset even if the market does not move at all.
Fully indexed rate = index + margin
The caps are what actually protect you
Caps are quoted as three numbers, for example 2/2/5:
| Cap | Limits |
|---|---|
| Initial | How far the rate can move at the first adjustment |
| Periodic | How far it can move at each later adjustment |
| Lifetime | How far above the initial rate it can ever go |
The lifetime cap is the number that matters most. On a 5.5% loan with a 5% lifetime cap, your worst case is 10.5% — and you should confirm you could still afford that payment before signing.
When an ARM makes sense
The reasoning fails when the plan depends on refinancing. Refinancing requires qualifying again, sufficient equity, and rates that have not risen — none of which are guaranteed.
- You are confident you will sell or refinance before the fixed period ends — a job with a known relocation, for instance.
- The initial discount against fixed rates is substantial, not the quarter-point it sometimes is.
- You could absorb the worst-case payment without distress if your plans change.
- Rates are historically high and you expect to refinance downward later.
Payment shock
Because the payment is recalculated on the remaining balance over the remaining term, a rate rise late in the fixed period compresses into fewer years and hits harder.
The worst-case column in the calculator applies the maximum increase the caps permit at every reset. It is not a forecast — it is the boundary of what your contract allows, and it is the figure to budget against.
Worked example
Using the values pre-loaded in the calculator above:
| Input | Value |
|---|---|
| Loan amount ($) | 400000 |
| Initial rate (%) | 5.5 |
| Fixed period (yrs) | 5 |
| Total term (yrs) | 30 |
| Adjusts every | 12 months |
| Index rate (%) | 4.3 |
| Margin (%) | 2.75 |
| Initial adjustment cap (%) | 2 |
| Periodic cap (%) | 2 |
| Output | Value |
|---|---|
| Initial payment (first 5 years) | $2,271.16 |
| Fully indexed rate | 7.05% |
| Payment after first adjustment | $2,625.78 |
| Payment change | +$354.62 |
| Total interest | $524,002.68 |
| Maximum rate | 10.5% |
| Maximum payment | $3,466.97 |
| Payment shock vs today | +$1,195.81 |
Frequently asked questions
What does 5/1 ARM mean?
The rate is fixed for the first five years, then adjusts once per year for the rest of the term. A 5/6 ARM adjusts every six months after the same five-year fixed period.
How high can my ARM rate go?
The lifetime cap sets the ceiling, measured from your initial rate. With a 5.5% start and a 5% lifetime cap, the maximum is 10.5% — regardless of how far the index rises.
Is an ARM cheaper than a fixed mortgage?
During the fixed period, usually yes. Over the full term it depends entirely on where rates go. If you keep the loan past the fixed period and rates rise, an ARM can cost considerably more.
What happens when the fixed period ends?
Your rate becomes the index plus your margin, constrained by the caps, and the payment is recalculated over the remaining term. If the fully indexed rate exceeds your starting rate, the payment rises.
Can I refinance out of an ARM?
Usually, but it is not guaranteed. You must qualify again at the time, hold enough equity, and accept whatever rates prevail. Never rely on refinancing as your only exit plan.