What Are the Advantages and Disadvantages of an Adjustable-Rate Mortgage?

The main advantage of an adjustable-rate mortgage (ARM) is a starting rate that is often lower than a fixed rate, which lowers your payment for the first 3 to 10 years. The main disadvantage is what happens next: the rate resets on a schedule to a market index plus a fixed margin, and your payment can rise as far as the loan's rate caps allow. An ARM fits best when you expect to sell or pay off the loan before the first reset, or when you could afford the highest payment the caps permit.

How does an ARM's rate change after the initial period?

An ARM name gives two numbers. A 5/6 ARM has a fixed rate for 5 years, then adjusts every 6 months. Fannie Mae and Freddie Mac buy SOFR ARMs with fixed periods of 3, 5, 7, or 10 years that then adjust every 6 months.

At each adjustment, the new rate is set from three parts:

• Index: a market interest rate the lender picks at application. For ARMs sold to Fannie Mae or Freddie Mac, it is the 30-day average of the Secured Overnight Financing Rate (SOFR), which the Federal Reserve Bank of New York publishes each business day. It was 3.89% on October 22, 2026. Fannie Mae uses the most recent value available 45 days before each change date.
• Margin: a fixed number of percentage points added to the index, set in your loan documents for the life of the loan. Freddie Mac requires a margin of 1 to 3 points, and Fannie Mae caps it at 3 points. Margins differ between lenders, and you can negotiate them.
• Caps: limits on each change. The initial cap limits the first adjustment, commonly 2 or 5 points. The subsequent cap limits each later adjustment, commonly 1 or 2 points. The lifetime cap limits the total rise over the starting rate, commonly 5 points. Caps are often written as three numbers, such as 2/1/5.

The index plus the margin is the "fully indexed rate." Fannie Mae rounds it to the nearest one-eighth of a point. Your new rate is the fully indexed rate unless a cap holds it lower. For how lenders set the starting rate, see how mortgage interest rates are calculated.

What is the worst-case payment?

Take a $400,000, 30-year 5/6 ARM at a starting rate of 6.50%, with a 2.75-point margin and 2/1/5 caps. These are example terms; your lender's will differ.

In the worst case, the payment rises by $1,260.46 a month, about 50%, within 18 months of the first reset. Each payment is recalculated on the remaining balance and remaining term. Taxes, insurance, and any mortgage insurance come on top.

The index can move that far. The 30-day average SOFR was 0.05% on October 22, 2021, and 3.89% on October 22, 2026, a rise of 3.84 points in five years.

What are the advantages of an ARM?

• Lower payments during the fixed period. Freddie Mac's average 30-year fixed rate was 7.32% on October 22, 2026. On $400,000, that is $2,747.72 a month, versus $2,528.27 at the example ARM's 6.50%: $219.45 a month less, or $13,167 over 5 years.
• A slightly lower balance at the reset. At the lower rate, more of each payment goes to principal. After 60 months, the example ARM balance is $374,444, versus $377,786 on the fixed loan.
• Your rate can fall. If the index drops enough that index plus margin is below your current rate, your rate falls at the next adjustment. The per-adjustment cap limits decreases as well as increases, and a Fannie Mae ARM never goes below its margin. A fixed-rate borrower would need to refinance, and pay closing costs, to get a lower rate.

An ARM does not always let you borrow more. Lenders test whether you can afford the loan at a qualifying rate, which can be higher than the note rate (the starting rate in your loan agreement). For a 5/6 ARM, Fannie Mae uses the higher of the fully indexed rate or the note rate plus 2 points. For the example 5/6 ARM, that is 8.50%, which is higher than today's average fixed rate. ARMs fixed for 3 years face a stricter test. For 7/6 and 10/6 ARMs, Fannie Mae generally qualifies you at the note rate.

What are the disadvantages of an ARM?

• Your payment can rise sharply. The worst case above adds $1,260 a month. If your budget could not absorb that, the CFPB suggests considering another loan.
• A plan to sell or refinance can fall through. The CFPB warns against assuming you can sell or refinance before the rate changes. Home values could fall, rates could rise, or your income or credit could change, and a refinance also costs closing fees.
• Comparing offers takes more work. Two lenders with the same starting rate can have different margins and caps, and those set every later payment. Ask each lender for the highest payment you could ever owe, and check it on your Loan Estimate.

For a side-by-side of both loan types, see the difference between fixed-rate and adjustable-rate mortgages.

Who should consider an ARM?

An ARM is worth pricing if one of these describes you:

• You expect to sell within the fixed period, for example because of a planned job move within 5 to 7 years.
• You have run the lifetime-cap payment ($3,789 in the example above) against your budget and could still cover your other bills and savings.
• You expect to pay the loan down well before the first reset, for example from the sale of another property.

A fixed rate is usually the better match if you plan to stay past the fixed period, have little room in your budget, or would need to refinance to afford the loan. If you like the lower start but need more time, a 7/6 or 10/6 ARM gives you more years before the first reset; compare its starting rate with the 5/6 and the fixed rate.

What happens before the first reset?

Federal rules require your servicer to send an initial notice 210 to 240 days before the first payment at the new rate is due. It shows your current and new rate and payment (marked as estimates if the index is not yet known), explains how the rate was set, and lists alternatives: refinancing, selling, a loan modification, or forbearance, plus housing counseling contacts. After that, you get a notice 60 to 120 days before each payment change. For more on these notices, see the rule on interest rate adjustment notices.

When the initial notice arrives, compare three options:

1. Keep the ARM if the new payment fits and the fully indexed rate is close to what a refinance would cost.
2. Refinance into a fixed rate or another ARM. You need enough equity, credit, and income to qualify at that time, and closing costs take months of payment savings to recover. See when to refinance your mortgage.
3. Sell if you were already planning to move.

For the conventional loan rules that apply to most ARMs, including credit and down payment minimums, see the requirements of a Fannie Mae or Freddie Mac loan.