What is Adjustable-Rate Mortgage (ARM)?

An adjustable-rate mortgage (ARM) is a home loan structured with an interest rate that remains fixed for an initial period and then adjusts periodically based on prevailing market conditions. ARMs are typically expressed as hybrid schedules, such as 5/1, 7/1, or 10/1, or 5/6m and 7/6m. Under a 5/1 ARM, for example, the borrower receives a locked 'teaser' interest rate for the first five years, after which the rate adjusts annually. In newer SOFR-based ARMs, adjustments frequently occur every six months (expressed as 5/6m). When an adjustment window opens, the new interest rate is calculated by adding a fixed lender margin (specified in the promissory note) to a fluctuating benchmark index rate, such as the Secured Overnight Financing Rate (SOFR).

To protect borrowers from extreme interest rate spikes, federal regulations require lenders to provide a Consumer Handbook on Adjustable-Rate Mortgages (CHARM booklet) and disclose specific interest rate caps. These caps establish legal boundaries: the 'initial cap' limits the rate change at the first adjustment, the 'periodic cap' limits adjustments from one period to the next, and the 'lifetime cap' sets the maximum rate that can ever be charged. While ARMs typically offer lower initial interest rates than comparable fixed-rate mortgages, they introduce significant long-term payment volatility. They are generally best suited for borrowers who plan to sell the property or refinance before the initial fixed-rate period expires.