An Adjustable Rate Mortgage (ARM) is a loan with an interest rate that changes over time. It begins with a fixed rate for an initial period—ranging from 1 month to 10 years—before adjusting periodically based on market conditions. ARMs typically have a 30-year term, with the interest rate determined by an index (such as the 1-Year Treasury or SOFR) plus a margin, which usually ranges from 1.75% to 3.5%.

Once the fixed period ends, the new rate is calculated by adding the margin to the index and rounding to the nearest 1/8%. This adjusted rate remains in effect until the next scheduled adjustment. Rate changes are controlled by caps, which limit how much the rate can increase at each adjustment and over the life of the loan.

For example, with a 5/1 ARM, an initial cap of 2%, and a lifetime cap of 5%, if the starting interest rate is 5.5%, the highest rate in year six would be 7.5%, and over the loan’s lifetime, it would not exceed 10.5%.