What is an adjustable rate mortgage?

A loan with a fixed rate for an initial period, after which the rate resets periodically against a published index. A 5/6 ARM is fixed for five years then adjusts every six months; a 7/1 is fixed for seven years then annually. The rate at each reset is the index plus a margin that never changes, subject to caps. The initial rate is lower than a comparable fixed loan because you are carrying the risk of future rises rather than the lender.

What do the caps 2/1/5 mean?

Three separate limits. The first number is the most the rate can move at the first adjustment, so two points. The second is the most at each subsequent adjustment, one point. The third is the most it can ever rise above the start rate across the whole loan, five points. On a 5.75% start that means the rate can never exceed 10.75%, however high the index goes. Some structures use 5/1/5, which allows a much larger first jump — worth checking, since it changes the shape of the risk considerably.

How much can my payment actually rise?

Exactly as much as the caps permit, which you can calculate before signing. On the worked example the payment goes from $2,917.86 to $4,439.61, a rise of fifty-two percent, reached eighteen months after the first adjustment. The jump is larger than the rate rise alone would suggest because each reset re-amortises the remaining balance over the remaining term, so you are paying a much higher rate on a nearly full balance across fewer years. That compounding of two effects is what people underestimate.

Is an ARM riskier than a fixed rate mortgage?

Yes, but the risk is bounded and it takes time to bite. The caps put a known ceiling on the rate, and the discount during the fixed period builds a lead that takes years to erode. On the worked example the ARM is cheaper than fixed until month 81 even on the worst path the contract allows. So the honest framing is not that ARMs are dangerous, but that they are a bet on your own horizon — safe if you are confident of leaving early, and increasingly expensive if you are not.

When does an ARM make sense?

When your horizon is comfortably shorter than the crossing point, and when you could absorb the worst case if you were wrong. That covers people who expect to move for work, buyers in a market where rates are high and expected to fall, and anyone whose income is likely to rise substantially. It suits badly anyone whose plans are uncertain, whose income is fixed, or who would be forced to sell if the payment jumped. The second test matters more than the first, because plans change and caps do not.

What is the fully indexed rate?

The index plus the margin, which is what your rate would become at the next reset if the index stayed exactly where it is today. It is the single most useful number on an ARM quote and is easy to overlook next to the teaser. If the fully indexed rate is already above the fixed offer, you are being shown a discount that expires rather than a genuinely cheaper loan — and the first adjustment will take you straight there, subject only to the first-adjustment cap.

What index do ARMs use?

Most American ARMs written now reference SOFR, the Secured Overnight Financing Rate, usually as a thirty-day average. It replaced LIBOR, which was phased out after 2021 and no longer exists for new lending. The index moves with short-term funding markets, so it responds to central bank policy fairly directly. The margin added on top is set by the lender at origination, is typically between two and three points, and never changes — which makes it worth negotiating, since it applies for the whole life of the loan.

Should I refinance before my ARM adjusts?

It depends on where rates are when the fixed period ends, which is precisely what you cannot know in advance. That is the flaw in the common plan of taking an ARM and refinancing before the first reset — it assumes an option that may not be available or affordable when you need it. Refinancing costs money, requires you still to qualify, and depends on the property having held its value. Treat it as a possibility worth having rather than a plan you are relying on.

What is payment shock?

The jump in the monthly payment at the first adjustment, and the reason lenders assess whether you could withstand it. It is larger than people expect for two reasons at once: the rate can move by the full first-adjustment cap in a single step, and the payment is recalculated over a term that is now several years shorter. On a 2/1/5 structure the first reset alone can add twenty percent to the payment. Underwriters sometimes qualify ARM borrowers at the fully indexed rate for exactly this reason.

Can an ARM rate go down?

Yes, and it is the half of the story that rarely gets told. If the index falls, the rate falls with it, bounded by the periodic cap in that direction too and by a floor that is usually the margin. Someone who took an ARM at a market peak and held it through a falling-rate period can end up substantially better off than a fixed borrower who would have to pay closing costs to refinance. That is the genuine upside of carrying the risk, and it is why an ARM taken when rates are high is a different proposition from one taken when they are low.

ARM vs Fixed Rate Mortgage Calculator

An adjustable rate is not open-ended. Three caps define exactly how bad it can get — the most it can move at the first adjustment, the most at each one after, and the most it can ever rise above where it started. Quoted as 2/1/5, that is two points, then one point at a time, stopping five points abo...

THE TWO LOANS

LOAN AMOUNT ($)

TERM (YEARS)

FIXED RATE (%)

ARM START RATE (%)

FIXED FOR (YRS)

ADJUSTS EVERY (MO)

YOU LEAVE AT (YRS)

EVEN AT ITS WORST, THE ARM STAYS AHEAD FOR

6y 9m

You expect to leave at 7y, which is past it. On the worst allowed path the ARM would cost $6,074 more than fixed by then — though only if rates actually do that.

SAVES NOW

$242.48/mo

WORST RATE

10.75%

WORST PAYMENT

$4,440

Know the worst case before you sign, because it is not gradual. The caps permit the rate to reach 10.75% by 6y 7m, taking the payment from $2,917.86 to $4,439.61 — up 52%. That is the number to ask yourself whether you could pay, because the contract allows it whether or not anyone expects it.

The teaser discount is a real head start. Paying $242.48 less for 5 years puts roughly $14,549 in your pocket and pays the balance down faster, which is why the ARM survives so long even on the worst path. The risk is not that rates rise — it is that they rise and you are still holding.

Leave at	Fixed	ARM worst	ARM at index	Cheaper
3 years	$595,858	$584,585	$584,585	ARM
5 years	$657,675	$638,883	$638,883	ARM
7 years	$717,550	$723,624	$700,533	Fixed
10 years	$803,121	$867,444	$788,789	Fixed
15 years	$931,657	$1,092,578	$921,745	Fixed
30 years	$1,137,722	$1,495,649	$1,136,429	Fixed

This is an estimate, not financial advice. It excludes fees, assumes no negative amortisation and no prepayment penalty, and treats the index as either rising to the caps, sitting at today level, or falling to the floor. Real indexes do none of those things exactly. Read the note for your own caps, margin, index and any conversion option before deciding.

THE RATE

The caps bound the risk, and the bound is high. The red line is the fastest rise the contract allows: 2% at the first adjustment, 1% at each one after, stopping at 5% above where it started. Nothing worse than that can happen — but nothing prevents that either.

Live calculation · updates as you type

Created with❤️byeaglecalculator.com

HOW TO USE

1
Take both rates from actual quotes on the same day. An ARM start rate and a fixed rate quoted a week apart are not comparable, since the whole market will have moved.
2
Open the caps section and enter your own. The 2/1/5 default is common but far from universal, and a 5/1/5 structure behaves very differently at the first adjustment.
3
Enter the index and margin separately. The margin is fixed for the life of the loan and is usually also the floor, so it sets how low the rate could ever fall.
4
Look at the worst-case payment before anything else, and ask whether you could pay it. If the answer is no, the rest of the comparison does not matter.

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Last updated: July 31, 2026 · Formula verified · Eagle-eyed accuracy for every calculation.