Quick answer: An adjustable-rate mortgage (ARM) may offer a lower starting payment for the first 5, 7, or 10 years. It can make sense if you expect to sell or refinance before the rate adjusts and could still afford a higher payment if your plans change. Refinancing is not guaranteed.
You find a home you like, start looking at the monthly payment, and wonder whether there’s a way to make the numbers more comfortable. Then you hear about an adjustable-rate mortgage with a lower starting rate.
It’s worth a look. Saving a few hundred dollars a month could give you more room to build savings or handle the expenses that come with a new home. But you’ll want to know what happens after that starting rate ends, especially if you’re still living there.
At Ideal Lending, we help you compare the initial savings with the potential future payment. That gives you a clearer picture of whether an ARM fits your plans.
Why buyers consider an ARM (Adjustable-Rate Mortgage)
An ARM may offer a lower starting interest rate than a comparable fixed-rate mortgage. When the difference is meaningful, the savings during those first several years can add up.
That can appeal to buyers who expect to relocate, sell, or pay off their mortgage before the rate begins adjusting. Other buyers are comfortable keeping an ARM longer because they have the income and savings to manage potential increases.
There’s no single rate difference that makes an ARM the better choice. You’ll want to compare upfront costs, monthly payments, and how long you expect to keep the loan.
How an ARM works
An adjustable-rate mortgage often starts with a rate that stays the same for several years. After that, the rate can change on a schedule set out in your loan agreement.
You may see these options:
| ARM type | Starting rate stays fixed for | Adjustments afterward |
|---|---|---|
| 5/6 ARM | 5 years | Every 6 months |
| 7/6 ARM | 7 years | Every 6 months |
| 10/6 ARM | 10 years | Every 6 months |
The first number tells you how long the starting rate lasts. The second tells you how often it can change afterward.
A five-year fixed period does not mean you must repay the loan in five years. For example, a 5/6 ARM may have a 30-year repayment schedule, with the rate fixed for the first five years.
Ideal Lending offers several ARM options. Available terms and requirements vary by loan program.
How is your new rate calculated?
When your fixed-rate period ends, your lender follows a formula written into your loan agreement. It adds two numbers:
- A market-based rate that can change, called the index.
- A set percentage that stays the same, called your margin.
For example, if the index is 4% when your rate adjusts and your margin is 2.75 percentage points, the calculation comes to 6.75%.
Your loan’s limits still apply. A cap may keep your rate from rising to that full amount at one adjustment, and a minimum rate, called a floor, limits how low it can go.
The example is hypothetical. Your loan documents show the specific index, margin, and limits used to calculate your rate.
How much can your ARM rate increase?
Your loan’s rate caps limit how much the interest rate can increase. They usually set three limits:
- How much the rate can increase the first time it adjusts.
- How much it can increase at each later adjustment.
- How high it can go over the life of the loan.
For example, 2/1/5 caps mean:
| Cap | What it means |
|---|---|
| 2 | The first increase can be up to 2 percentage points. |
| 1 | Later increases can be up to 1 percentage point each. |
| 5 | The rate can never rise more than 5 percentage points above the starting rate. |
What could that mean for your monthly payment?
Let’s use a hypothetical $320,000 mortgage with a 30-year repayment term. The starting interest rate is 6.00%, fixed for five years. After that, the rate can adjust every six months, with 2/1/5 caps.
For the first five years, your monthly principal and interest payment would be about $1,919.
At the first adjustment, the rate could rise by up to two percentage points, from 6.00% to 8.00%. If it did, your payment would increase to about $2,298 a month, roughly $379 more.
After that, the rate could increase by up to one percentage point every six months, until it reaches the lifetime limit of 11.00%. If it rose as quickly as those caps allow, your payment would reach about $2,904 a month after 6½ years, roughly $985 more than your starting payment.
That is a maximum-increase example, not a prediction. Your actual adjustments would depend on your loan’s rate calculation and limits.
These payments include principal and interest only. Property taxes, insurance, and any HOA or condominium dues would be additional.
ARM vs. fixed rate vs. a 2-1 buydown
Each option affects your payment differently. The main question is how long the starting payment lasts and what happens afterward.
An ARM: a lower starting rate may mean early savings
An ARM may offer a lower starting rate than a fixed-rate mortgage. That rate stays fixed for an initial period, often five, seven, or ten years. Afterward, your rate and payment can change according to the loan’s terms.
It may be worth considering if the savings are meaningful and you could afford a higher payment later.
A fixed-rate mortgage: predictable principal and interest payments
Your interest rate stays the same for the life of the loan, so your monthly principal and interest payment stays the same, too.
The starting rate may be higher than an available ARM, but you know what that part of your payment will be years from now. Taxes and insurance can still change your total monthly payment.
A 2-1 buydown: help with the first two years of payments
A 2-1 buydown uses money set aside at closing, often contributed by the seller, to cover part of your payments temporarily.
In year one, your share of the payment is calculated as though the interest rate were two percentage points lower. In year two, it is calculated as though the rate were one point lower. Starting in year three, you pay the full amount.
Your mortgage’s actual interest rate does not change. The buydown funds make up the difference, so you need to be comfortable with the full payment from the start.
An Ideal Lending loan officer can help you compare the initial savings, upfront costs, and future payments for the options available to you.
What is a 2-1 buydown?
With a 2-1 buydown, funds provided at closing, often by the seller, temporarily reduce what you pay each month.
For the first year, your share of the principal and interest payment is calculated as though the rate were two percentage points lower. In the second year, it is calculated as though the rate were one point lower. Starting in year three, you pay the full amount.
The mortgage’s actual interest rate does not change. The money set aside at closing makes up the difference during those first two years.
Some ARM programs also permit temporary buydowns. Your loan officer can explain which options are available and help you compare them using our Buydown Calculator.
How long do you expect to keep the mortgage?
Think about how long you expect to keep this loan, then leave room for the possibility that your plans change.
Less than five years: A 5/6 ARM may be worth comparing with a fixed-rate mortgage. Look at how much you would save after accounting for any difference in upfront costs. Also consider whether you could afford the ARM if your move or sale takes longer than expected.
Five to ten years: A 7/6 or 10/6 ARM could keep your rate fixed for much of that time. Compare the starting payment with a fixed-rate loan, and check when the first adjustment would happen and how much the rate could increase.
More than ten years, or you’re unsure: A fixed-rate mortgage gives you a predictable principal and interest payment for the full loan term. An ARM may still be worth considering if the savings are meaningful and your budget can comfortably handle future adjustments.
You don’t need to know exactly where you’ll be in ten years. Choose a mortgage that fits your plans today and gives you room if life takes a different direction.
Can you just refinance before the rate adjusts?
You can apply to refinance before an ARM adjusts. But refinancing means getting a new mortgage, so you’ll need to qualify again.
Several things can affect your options:
- Your income and debts: The lender needs to confirm that you can afford the new loan.
- Your credit: Your credit history and score can affect approval and pricing.
- Your home’s value: Many programs look at how much you owe compared with what the home is worth. Your equity is the difference between those amounts.
- Available rates: The new loan should help you meet a goal, such as reducing costs or getting a steady principal and interest payment.
- Closing costs: Compare what the refinance costs with what you expect to gain.
- The new loan term: A new 30-year loan may reduce your payment while extending how long you’ll be paying the debt.
The rules vary by refinance program.
Rates do not have to fall for refinancing to be useful. You might refinance into a fixed-rate mortgage because you want payment stability. But your finances or the available loan options could change, so refinancing should not be the only way you can afford the home later.
Read more about when to refinance your mortgage.
When might an ARM be a good fit?
An ARM may be worth considering if the initial savings are meaningful and you can handle the possible payment changes.
You might be comfortable with an ARM if you:
- Expect to sell or pay off the mortgage before the rate adjusts.
- Have room in your budget for higher payments if you keep it longer.
- Have savings available for unexpected expenses.
- Understand the loan’s adjustment schedule and caps.
A fixed-rate mortgage may suit you better if you:
- Expect to keep the mortgage for many years.
- Prefer knowing your principal and interest payment will stay the same.
- Have limited room for a payment increase.
- Would need a future raise or refinance to afford an adjusted payment.
Make the decision using the finances you have today. A future raise could help, but it should not be essential to keeping the payment manageable.
Already have an ARM? Start planning before it adjusts
Consider reviewing your options 6 to 12 months before the first adjustment. That gives you time to compare choices without rushing.
- Find the date. Check your loan documents for when the rate changes and when the first adjusted payment is due.
- Review the calculation. Find your index, margin, and rate caps.
- Check your full monthly cost. Include taxes, insurance, and any changes to your escrow payment.
- Gather your information. Have a recent mortgage statement and current income documents available.
- Compare your options. Look at the likely cost of keeping your ARM alongside the costs and terms of refinancing.
Watch for adjustment notices from your mortgage servicer, too.
You do not automatically need to refinance because the fixed period is ending. Keeping the ARM may make sense, depending on its terms and the alternatives available.
Frequently Asked Questions
Is an ARM a good idea right now?
It can be if the savings are meaningful, the initial fixed period fits your plans, and you could afford higher payments later. Compare actual loan offers rather than choosing based only on predictions about future rates.
Can my ARM rate go down?
Yes. Your rate can decrease if the calculation in your loan agreement produces a lower rate, subject to the loan’s limits. A minimum rate, or floor, limits how low it can go.
Will my rate stay the same if market rates don’t rise?
Not necessarily. Your starting rate may be lower than the rate produced by the index-plus-margin calculation. When the fixed period ends, that calculation could result in an increase even if the index has not risen.
What happens if I can’t refinance?
Your current mortgage continues under its original terms, including its adjustment schedule and caps. The end of the fixed-rate period does not, by itself, make the entire loan balance due.
Does my mortgage start over when the rate adjusts?
No. For a loan with payments that cover interest and pay down principal, the new payment is generally based on the remaining balance, adjusted rate, and time left to repay it. A rate adjustment does not start a new 30-year loan.
Will an ARM help me qualify for a more expensive home?
Not necessarily. The lender may evaluate your ability to repay using a rate higher than your starting rate. Your loan officer can explain the requirements for the program you’re considering.
Can I use Florida down payment assistance with an ARM?
It depends on the assistance program. Some require a fixed-rate mortgage, so choosing an ARM could affect which programs you can use. Ideal Lending can help you compare an ARM’s potential monthly savings with the upfront help available through an eligible fixed-rate loan.
Compare your options with Ideal Lending
How much would an ARM save you at the start? What could the payment look like later? Would a fixed rate or temporary buydown fit your budget better?
An Ideal Lending loan officer can help you compare the payments, upfront costs, and potential changes using your price range and plans.
