How an ARM works
An adjustable-rate mortgage starts with a fixed rate for a set number of years, then the rate resets periodically for the rest of the loan. The name tells you both parts: a 5/6 ARM is fixed for 5 years, then adjusts every 6 months; a 7/6 and a 10/6 are fixed for 7 and 10 years, then also adjust every 6 months. The time between resets is the adjustment period.
At each reset the new rate is set by a formula written into your loan:
new rate = index + margin, limited by the caps
The index is a published market rate that moves with the economy. Fannie Mae's standard ARMs use the 30-day average of SOFR (the Secured Overnight Financing Rate). The margin is a fixed number of percentage points the lender adds on top, set when you get the loan. The CFPB explains that the index can change but the margin stays the same after closing, and that margins can differ a lot between lenders.
Each time the rate changes, the payment is recalculated on the balance you actually owe, over the months left, so the loan still pays off on time. The calculator does the same.
The caps
Caps limit how far the rate can move. They're written as three numbers, like 2/1/5: the most the rate can change at the first adjustment, at each later adjustment, and over the lifetime of the loan, above the starting rate. Fannie Mae's standard 5/6 ARM uses 2/1/5 caps; its 7/6 and 10/6 ARMs use 5/1/5, so their first reset can jump further. The CFPB's guide to rate caps notes that first caps are commonly 2 or 5 points, later caps 1 or 2, and lifetime caps most often 5.
ARMs also have a floor, the lowest the rate can go. The CFPB's Consumer Handbook on Adjustable-Rate Mortgages says an ARM's rate is generally never lower than the margin, which is why the calculator suggests the margin as the floor.
Example: a 5/6 ARM three ways
Nobody knows where the index will be in five years, so the calculator lets you choose: the rate steps toward the rate you expect, rises as fast as the caps allow (the worst case), or falls as far as they allow, down to the floor (the best case). Take a $320,000 loan over 30 years ($400,000 home, $80,000 down) as a 5/6 ARM at 6% with 2/1/5 caps and a 2.75% floor. For five years the payment is $1,918.56 a month in principal and interest.
- Expected rate of 7%: the first cap allows 2 points, so the rate goes straight to 7% and the payment becomes $2,104.61 from payment 61. Total interest: about $426,500.
- Worst case: 8%, 9%, 10%, then 11% at resets six months apart. The payment climbs to $2,298.27, $2,496.49 and $2,698.66, and peaks at $2,904.21 from payment 79, about $986 a month more than at the start. Total interest: about $659,100.
- Best case: 4%, 3%, then the 2.75% floor, with the payment falling to $1,377.45. Total interest: about $209,700.
Example: a longer fixed period, a bigger first jump
Make the same loan a 7/6 ARM at 6%, with 5/1/5 caps. The payment stays at $1,918.56 for seven years. In the worst case the 5-point first cap lets the rate go from 6% to its 11% ceiling in one step, so the payment jumps to $2,859.88 at payment 85. As a 10/6 ARM, the same jump comes three years later, to $2,764.14 from payment 121. When you compare ARM types, look at both the highest payment and how suddenly it could arrive.
When an ARM makes sense
An ARM's lower starting rate helps most if you expect to sell or refinance before the fixed period ends. The risk is the reset: plan for the worst-case payment, not the expected one. To weigh an ARM against a fixed-rate loan over the years you'll actually keep it, put both side by side in the loan comparison.
Pitfalls and things to check
- Your loan's real terms. The index, margin, rate limits and how often the rate changes are in the Adjustable Interest Rate (AIR) table on page 2 of your Loan Estimate. Enter those rather than relying on the presets.
- The expected rate is only an estimate. The index can move either way, so treat the worst case as the number to budget for.
- Refinancing isn't guaranteed. If rates are higher, your home's value falls or your income changes, a refinance may cost more or not be available when the fixed period ends. The refinance calculator can show whether a new loan would pay off.
- Some reset details aren't modeled, such as the date the index is read and how the lender rounds the new rate. See how we calculate.
Common questions
What does 5/6 mean on an ARM?
The rate is fixed for the first 5 years, then adjusts every 6 months until the loan is paid off. A 5/1 ARM, by the same naming, adjusts once a year after its fixed period.
What does 2/1/5 mean?
It's the cap structure: up to 2 points of change at the first reset, up to 1 point at each reset after that, and never more than 5 points above the starting rate.
What is SOFR?
The Secured Overnight Financing Rate, a measure of overnight borrowing costs published by the Federal Reserve Bank of New York. Fannie Mae's standard ARMs use its 30-day average as the index.
Can my ARM payment go down?
Yes, if the index falls, by up to the cap at each reset but never below the floor. Choose “Falls as far as the caps allow” to see the lowest it could get.
Can I pay extra on an ARM?
Check your loan for a prepayment penalty first. Extra principal lowers the balance, so each later reset works out a smaller payment. Try it above, or see the extra payment calculator.