The initial rate on an Adjustable-Rate Mortgage (ARM) is now 4.04%.  The average fixed rate on a 30-Year fixed-rate mortgage stands at 5.49% currently.

ARMs – Not Only About Initial Interest Rate

Adjustable-rate mortgages, ARMs, are currently experiencing a resurgence in popularity.  Demand has increased +10% since the traditionally favored 30-year fixed-rate single-family interest rate has increased from approximately 3.1% at the beginning of 2022 to more than 5% currently.

By comparison, the initial interest rate of an adjustable-rate mortgage on 5/1 ARM stands at 4.04%.  (Interest rate quotes change weekly so what is written here today may not apply at the time of your reading this article.)


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The Basics of ARMS

David Mendels, director of planning with Creative Financial Concepts in New York, said, “There is a lot of variability in the specific terms (of ARMS) as to how much the rates can go up and how quickly.  No one can predict what rates will do, but one thing is clear – there is a whole lot more room on the upside than there is on the downside.”

Think about the name, adjustable-rate mortgage.  A 5/1 ARM tells consumers that the introductory rate of the mortgage lasts five years (the “5”).  After five years, that introductory rate can change once every year (the “1”).

Some lenders offer a 3/1 ARM with the initial rate lasting three years, a  5/1 ARM with the initial rate lasting five years, a 7/1 ARM with the initial rate lasting seven years, and a 10/1 ARM with the initial rate lasting ten years.

After knowing how long the initial rate would last and how often that rate could change, consumers need to know how much the initial rate would be adjusted AND what the maximum rate charged would/could be.

Know that the interest adjustment would likely NOT be an increase of just 1 – 2%.  Most mortgage lenders also add an agreed-upon percentage point (called the margin) to get to the total rate an ARM borrower would pay.  Know that the interest rate ARM borrowers would pay depends on the contract terms so READ THE CONTRACT BEFORE SIGNING IT.

Understand Contract Terms

Know that ARMs generally come with caps on each annual adjustment over the life of the loan.  Know that these caps vary among lenders so, understand these terms:

  • Initial Adjustment Cap – The cap indicates how much the interest rate can increase the first time the ARM is adjusted after the fixed-rate period ends. It’s common for the cap to be no more than 2% higher than the initial rate during the fixed-rate period.
  • Subsequent Adjustment Cap – This cap indicates how much the interest rate can go up in the adjustment periods that follow. Commonly, this number is +2%, meaning that the new rate can’t be more than 2% higher than the initial adjustment cap.
  • Lifetime Adjustment Cap – This cap indicates how much the interest rate can go up over the total life of the loan. Commonly, this number is 5%, meaning that the rate can never be 5% points more than the initial rate.  BUT some lenders have higher caps.

Pros & Cons of ARMS

ARMS make sense for buyers who anticipate moving before the initial rate period (3/1. 5/1, 7/1, 10/1) expires.  (However, know that life happens and buyers may not be able to move prior to the initial rate period expiring.)  ARMs also make sense for expensive homes because the difference between the initial rate on an ARM and a 30-year fixed could be thousands of dollars a year.

ARMS do not make sense for mortgages less than $200,000 simply because the savings are less comparatively with a fixed-rate mortgage.  ARMs do not make sense for mortgage on “forever homes.” They also don’t make sense if the buyer is putting down a low down-payment because, according to Stephen Rinaldo, president and founder of the mortgage broker Rinaldi Group, “If the market corrects for whatever reason and home values drop, you could be underwater on the house and unable to get out of the ARM.”

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