Fixed or Adjustable: How ARMs Actually Reset
The teaser rate is the advertised part. The caps and the index decide what happens after.
A fixed-rate mortgage holds one rate for the whole term. An adjustable-rate mortgage opens lower, holds that rate for an initial period, then resets on a schedule for the rest of the loan. The opening gap is the part lenders advertise, and it tells you almost nothing about what the loan will cost.
Reading the numbers in an ARM's name
A 5/6 ARM holds its initial rate for five years, then adjusts every six months. A 7/1 ARM holds for seven years and then adjusts annually. The first number is the fixed period in years. The second is how often it moves after that.
What the rate resets to
After the fixed period, your rate becomes an index plus a margin.
The index is a published benchmark that moves with market conditions. Most US ARMs written now reference SOFR, the Secured Overnight Financing Rate. You do not control it and neither does the lender.
The margin is a fixed number the lender adds, set when you take the loan and unchanged for its life. A margin of 2.75% means your rate is always the index plus 2.75, subject to the caps below.
The margin is worth attention at application, because it is the part that differs between lenders and the part locked in permanently. Two ARMs with identical teaser rates and different margins are different loans.
Caps, which decide your worst case
Caps limit how far the rate can move. They are usually written as three numbers, such as 2/1/5.
| Cap | What it limits | Typical |
|---|---|---|
| Initial | The first adjustment after the fixed period | 2% |
| Periodic | Each subsequent adjustment | 1% |
| Lifetime | Total increase above your starting rate | 5% |
The lifetime cap is the number to plan around, because it defines the worst case you have agreed to. Take the starting rate, add the lifetime cap, and calculate the monthly payment at that rate. If you could not carry that payment, the loan is asking you to bet on the index.
Run the worst case
Ask the lender for the payment at the fully capped rate before you sign, not the payment at the teaser rate. Lenders can produce this in seconds and it is the single most useful figure for deciding whether an ARM suits you.
When an ARM makes sense
The case for an ARM rests on your time horizon. If you will sell or refinance before the fixed period ends, you captured a lower rate and never faced a reset.
That works for buyers with a known timeline: a job posting with a fixed term, a starter home you expect to outgrow, a property you plan to sell within five years. It also works if you have enough income headroom that the capped payment would be uncomfortable rather than impossible.
The plan that fails is refinancing before the reset with no ability to carry the reset if refinancing turns out not to be available. Refinancing depends on rates, on your credit at that future date, and on your home's value. None of those are promised.
When fixed makes sense
If you intend to stay put, a fixed rate removes the question. Your principal and interest payment on a 30-year fixed is the same in year 28 as in year 1, which makes long-range planning possible in a way an ARM does not.
Your total housing payment still moves, because property taxes and insurance are not fixed and both have risen sharply in many states. A fixed-rate mortgage fixes the loan, not the bill.
Terms worth checking before signing an ARM
- Which index, and where you can look it up yourself.
- The margin, and how it compares between lenders.
- All three caps, and the payment at the fully capped rate.
- Any floor, which sets a rate below which your loan will not go even if the index falls.
- Prepayment penalties, which would undercut a plan built on refinancing.
- The lookback period, meaning the date the index value is taken from for each adjustment.
All of it appears in your loan documents. The adjustment terms are the part of a mortgage most borrowers skip, and on an ARM they are the part that determines what you pay.
This article is general information about how consumer finance products work in the United States. It is not financial, tax or legal advice and is not a recommendation of any specific product or provider. Rules and pricing vary by state and by institution.