Adjustable-Rate Mortgage (ARM): Index, Margin and Caps

How an ARM works

The CFPB’s Consumer Handbook on Adjustable-Rate Mortgages (CHARM) defines an ARM as a mortgage whose rate “adjusts” throughout the loan. Under 12 CFR 1026.19(b)(1), lenders must provide this booklet, or a suitable substitute, when the annual percentage rate may increase after closing on a loan secured by your principal dwelling with a term over one year.

An ARM has two phases:

1. Initial period. The initial rate and the initial principal-and-interest payment stay the same for a limited time.
2. Adjustment period. The rate then changes at regular intervals, and the payment can go up or down.

Reading the name. In a 5/1 or 5/6m ARM, the first number is how long the initial rate lasts. The second is how often the rate changes after that. In a 5/6m ARM, the rate stays the same for five years, then may adjust every six months until the loan is paid off. Freddie Mac’s SOFR ARM fact sheet (November 2022) lists 3/6-month, 5/6-month, 7/6-month and 10/6-month SOFR-indexed ARMs; a “5/1” adjusts once a year after year five.

Index plus margin

After the initial period, your new rate is calculated as:

Index + Margin = Interest rate (subject to caps)

• Index: a measure of interest rates that moves with the market. The CHARM booklet names the U.S. prime rate and the Constant Maturity Treasury (CMT) rate as common indexes. For loans sold to Fannie Mae and Freddie Mac, the index is now SOFR: Fannie Mae’s Selling Guide (B2-1.4-02, December 10, 2025) says its ARM plans “must be tied to the Secured Overnight Financing Rate (SOFR) Index”, and Freddie Mac’s fact sheet says both companies require the 30-day Average SOFR, published by the Federal Reserve Bank of New York since March 2, 2020. The lender chooses the index when you apply; it generally does not change after closing.
• Margin: the percentage points the lender adds to the index. The CFPB says the margin “is set in your loan agreement and won’t change after closing”, can vary a lot between lenders and can be negotiated. For SOFR ARMs sold to Freddie Mac, the margin must be between 1.00 and 3.00 percentage points (100 to 300 basis points).
• Fully indexed rate: index plus margin.

Generally, an ARM’s rate is never lower than the margin, according to the CHARM booklet.

Fully indexed rate today, step by step. The New York Fed’s 30-day Average SOFR for November 3, 2026 was 3.90759%. With an illustrative margin of 2.75% (inside Freddie Mac’s 1% to 3% range), the fully indexed rate would be 3.90759% + 2.75% = 6.65759%, before any rounding your note specifies. Your actual margin is the one in your loan agreement.

Teaser rates. Some loans start below the fully indexed rate. The CHARM booklet gives this example: index 2%, margin 2.5%, so a fully indexed rate of 4.5%, with a teaser rate of 3%. Even if the index does not move, the rate rises from 3% to 4.5% when the teaser ends.

The three kinds of rate caps

Caps limit how far the rate can move. The CFPB describes three:

Lenders often write caps as three numbers in that order: a “2/1/5” loan has a 2-point first cap, a 1-point cap on each later change and a 5-point lifetime cap. Some loans have a higher lifetime cap. Some have a different limit on decreases, called a floor. Two lenders can offer the same initial rate with different caps, so compare caps as well as rates.

Worked example: the worst case on a 5/6m ARM

Arbitrary figures, not an offer: a $300,000, 30-year 5/6m ARM at an initial 6.00%, with 2/1/5 caps. Payments are principal and interest, computed with the standard amortization formula.

How the numbers are built: after 60 payments at 6.00%, the balance is $279,163.07. At the first change, the lender re-amortizes that balance over the 300 remaining months at the new rate. At the lifetime maximum, the payment is $924.04 higher than at the start ($2,722.69 − $1,798.65), or about 51% more. If SOFR stays where it was on November 3, 2026 and the margin is 2.75%, the rate would instead reset to about 6.66%, a payment near $1,927 on the remaining balance.

Is a 5/1 or 5/6m ARM worth it?

It depends on how long you keep the loan and on the rate gap with a fixed loan on the day you shop. Two calculations frame the decision:

1. What you save during the fixed period. With arbitrary rates of 6.00% (ARM) and 7.00% (30-year fixed) on $300,000, the ARM payment is $197.26 lower per month ($1,798.65 vs $1,995.91): $11,835 over 60 months. The ARM balance after 5 years is also $3,232 lower ($279,163 vs $282,395), because less of each payment goes to interest.
2. What you risk after it. In the table above, the ARM payment can reach $2,154.63 in month 61, already above the fixed payment, and $2,722.69 at its lifetime cap.

An ARM tends to fit if you are confident you will sell or refinance before the first reset, and you could carry the capped payment if you cannot. The CFPB warns that refinancing is not guaranteed: you may not qualify if your home’s value drops or your finances change. Freddie Mac stopped publishing a weekly 5/1 ARM average in November 2022, so compare ARM and fixed quotes from the same lender on the same day.

How lenders qualify you for an ARM

To limit payment shock, Fannie Mae’s Selling Guide (B3-6-04) sets the rate used to test your debt-to-income ratio:

• Initial fixed period of 5 years: the greater of the note rate plus the first rate-change cap, or the fully indexed rate.
• 3 years or less: the maximum rate that could apply during the first five years.
• More than 5 years: at least the note rate (the fully indexed rate also applies to higher-priced loans).

In the example above, a 5/6m at 6.00% with a 2-point first cap is qualified at 8.00% or more: a payment of $2,201.29 on $300,000, not $1,798.65. See debt-to-income ratio.

Reading the AIR table on your Loan Estimate

Page 2 of the Loan Estimate has an Adjustable Interest Rate (AIR) table. The CHARM booklet’s sample shows a 30-year 5/1 ARM of $216,000:

• Index + margin: 1-year CMT + 2.25%
• Initial rate: 3%
• Minimum/maximum rate: 2.25% / 8%
• First change: beginning of the 61st month; then every 12 months
• Limit on changes: 2% at the first change, 2% after

In that sample, the principal-and-interest payment starts at $910.66 and can reach $1,467 in year 8. These are the booklet’s illustrative figures, not offers.

Rate-change notices: how much warning you get

Regulation Z (12 CFR 1026.20) sets two notices from your servicer:

Exceptions: neither notice applies to ARMs with a term of one year or less. If the first adjusted payment is due within 210 days of closing, the first-adjustment notice is given at closing. For ARMs that adjust every 60 days or more often, the payment-change notice window is 25 to 120 days.

Risks to check before choosing an ARM

• Payment increases. The CFPB says your payment could go up a lot, even double, once the rate starts adjusting.
• Refinancing is not guaranteed. You may not qualify if your home’s value drops or your finances change. See refinancing.
• Points. Paying points on an ARM often lowers the rate only until the end of the initial period, not over the life of the loan. See mortgage discount points.
• Interest-only and payment-option ARMs. Payments rise when the interest-only period ends. A minimum payment can cause negative amortization, where the balance goes up instead of down.
• Conversion option. Some ARMs let you convert to a fixed rate later, possibly for a fee.

Ask the lender to calculate the highest payment you could ever owe and check it against your budget and your debt-to-income ratio. To compare with a fixed loan, see 15-year vs 30-year mortgage.