ARM Mortgage Explained: 5/1, 7/1, and the Payment Shock to Expect
An adjustable-rate mortgage (ARM) trades a lower intro rate for future uncertainty: your payment is fixed for a few years, then can rise with market rates. Done right, an ARM saves thousands. Done blind, it is the payment shock people regret. Here is how they actually work and how to decide.
The two periods
Every ARM has a fixed intro period followed by adjustments. A 5/1 ARM keeps one rate for 5 years, then adjusts once a year; a 7/1 ARM is fixed for 7 years, then adjusts annually; a 10/1 is fixed for 10. The intro rate is usually below the 30-year fixed rate — that is the incentive. The trade is that after the intro period, your rate follows the market.
How the adjustment is calculated
At each adjustment, your new rate equals the current index plus your margin. Most modern ARMs use SOFR as the index; the margin is fixed at origination, commonly around 2 percentage points. If SOFR is 4.5% and your margin is 2.0%, the fully-indexed rate is 6.5%. Rate caps limit how fast the rate can move: typically 2 percentage points per adjustment and 5 over the life of the loan. A 5.5% intro rate therefore cannot jump above 7.5% at the first adjustment, no matter what the index does.
The payment shock, by the numbers
On a $400,000 30-year loan, a 5.5% intro payment is about $2,271 a month. If the rate hits 7.5% at the first adjustment, the remaining balance re-amortizes and the payment jumps to about $2,733 — roughly $462 more per month, before insurance and taxes. That is the number to plan around, and the ARM calculator runs it for your exact loan. The standard mortgage calculators assume a fixed rate, so they cannot show this.
When the ARM actually wins
An ARM beats a fixed rate when you will not hold the loan through the adjustments — typically selling or refinancing within the intro period. The lower intro payment then applies for your entire time in the house, and the interest saved is pure gain. The risk is the plan changing: rates are high at adjustment, you cannot refinance, and the payment rises while you wanted to stay. Borrowers who accept that risk are betting their horizon, not the market.
What lenders rarely advertise
Your payment can also rise even when rates fall, because of how the loan amortizes — but the bigger hidden cost is negative amortization on option ARMs, which most lenders no longer offer. What you will see instead: the 2/5 caps quoted above, a possible payment cap that delays principal, and the fact that the fully-indexed rate (not the intro teaser) determines what you can actually qualify for. Compare the fully-indexed payment, not the teaser, when stress-testing your budget.
Fixed-rate comparison
Run the same loan as a fixed 30-year with the mortgage payment calculator, and the 15-year option with the 15 vs 30 calculator, then see what refinancing could do if rates fall with the refinance calculator. The ARM wins only when your horizon is short enough to keep the intro payment for the whole time you hold the loan.
Sources: Consumer Financial Protection Bureau — adjustable-rate mortgage disclosures (H-4(H)); Federal Reserve — SOFR index reference; standard 2/5 rate-cap structure per CFPB guidance.