HomeDealMath

ARM Calculator (7/1 Adjustable Rate Mortgage)

Initial fixed rate, worst-case reset, lifetime cap. The 3 numbers that decide if an ARM is right for you.

Inputs

Results

Initial Monthly P&I
$2,366

After Fixed Period

Expected (rate 8%)$2,839
Worst case at first reset$2,810
Worst case lifetime (rate 10.875%)$3,535
Stress test: If rates hit the lifetime cap, your payment increases by $1,169/month after the fixed period. Could you absorb that?
Total Interest (best case)$582,207
Total Interest (worst case)$774,482
Δ between scenarios$192,274

Sam's Take

ARMs make sense for two specific situations: (1) you'll definitely move or refinance before the fixed period ends, or (2) you have enough income headroom to absorb the worst-case lifetime cap and want the lower initial rate. Outside those two, ARMs are a gamble. The 2008-2010 crisis was largely caused by people taking ARMs they couldn't afford if rates rose — and rates rose. Don't be that person. Run the worst-case lifetime payment, ask 'can I afford this?' If no, take the fixed.

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What an ARM is, and why people take them

ARM stands for adjustable-rate mortgage. It's a loan where the interest rate is fixed for an initial period — usually 5, 7, or 10 years — and then resets every year after that based on a market index. A "5/1 ARM" means the rate is fixed for 5 years, then adjusts every 1 year afterward. A "7/1 ARM" means fixed for 7 years, then adjusts annually. And so on.

The reason people take an ARM instead of a 30-year fixed: the initial rate is usually 0.5% to 1.5% lower. On a $400K loan, that's $130-400 a month in savings during the fixed period. The catch is that once the fixed period ends, your rate can go up — sometimes a lot — and your payment goes up with it.

The three caps that limit how bad it can get

ARMs come with three rate caps written in the contract, usually shown as something like "5/2/5" or "2/2/5":

  • First adjustment cap. The maximum the rate can jump at the very first reset. Usually 2 or 5 percentage points above the starting rate.
  • Periodic cap. The most the rate can change at each annual adjustment after that. Usually 2 percentage points per year.
  • Lifetime cap. The maximum the rate can ever go above where it started, for the whole life of the loan. Usually 5 percentage points.

So a 5/1 ARM with 5/2/5 caps starting at 6%: at the first reset (year 6) the rate can jump to anywhere up to 11%. At year 7 it can move 2% from there. The rate can never go above 11% no matter what happens to the broader market. That's your worst case — and the calculator above shows you what your monthly payment looks like at that worst case.

When ARMs make sense, and when they wreck people

ARMs work for two specific situations: (1) you know you're going to sell or refinance before the reset hits, or (2) you have enough income headroom that the worst-case payment still doesn't break you.

Outside those two, ARMs are a gamble. The 2008-2010 housing crash was largely caused by people taking ARMs they couldn't actually afford if rates rose — and rates rose. The pattern was: take the lower rate because the payment fits today, ignore the worst case, and then year 6 hits and the payment jumps 30-40% and you can't refinance because the home value dropped and you're underwater. Foreclosure follows.

Don't be that person. Run the worst-case lifetime payment in the calculator and ask: can I still afford this? If the answer is no — even if you "plan to refinance before then" — take the fixed-rate. Plans change. Rates don't care about your plans.