Adjustable-Rate Mortgages (ARM): Teaser Rates, Caps & Payment Shock
An Adjustable-Rate Mortgage (ARM), such as a 5/1, 7/1, or 10/1 hybrid ARM, offers a lower introductory "teaser" interest rate for a fixed initial period (5, 7, or 10 years). Afterward, the rate adjusts annually based on benchmark indices (SOFR) plus a lender margin.
Understanding ARM Rate Adjustment Caps (e.g. 2/2/5 Structure)
- Initial Cap (First Number): Maximum the rate can increase at the first adjustment date (e.g., 2%).
- Periodic Cap (Second Number): Maximum the rate can change in any subsequent adjustment year (e.g., 2%).
- Lifetime Cap (Third Number): Absolute maximum the interest rate can ever rise above the initial rate (e.g., 5%).
Worst-Case Monthly Payment Calculation
Borrowing $300,000 on a 5/1 ARM at a 6.0% initial rate costs $1,798.65 / month. If rates jump to the 11.0% lifetime cap after year 5, the monthly payment increases by over $1,000 to $2,809.50 / month.
