How ARM rates work: 3/1, 5/1, 7/1 and 10/1 mortgages

January 21, 2019 - 6 min read

ARM rates more attractive for buying and refinancing

Adjustable-rate mortgages, or ARMs, have been the ugly stepchildren of the mortgage world for years. But consumers are changing their tune. Analysts at mortgage data firm Ellie Mae claim that ARMs made up 8.9 percent of all mortgages closed in November 2018.

That number has risen significantly since 2016. Back then, less than 1 in 20 mortgage applicants wanted an ARM.

As fixed rate mortgages become more expensive, and home prices continue to rise, expect to see ARM rates attract a new following.

Call to ARMs: fixed rates on the move

Back in 2005, says the New York Federal Reserve, ARMs had nearly 40 percent of the mortgage market share. In December of 2005, 30-year fixed rates averaged 6.27 percent.

That’s not much of a jump from where we are now. Many experts predict that rates will be in the mid-5s by the end of 2019. It’s not unthinkable for rates to hit the sixes on the next few years.

A Harvard study explains that when ARMs are significantly cheaper than fixed-rate mortgages, and home prices are rising, adjustable rate loans become more popular. This allows consumers to buy more house for their money.

ARMs vs fixed: when ARMs are strong

If you plan to buy a house or refinance a mortgage any time in the near future, you should consider ARM loans along with fixed-rate mortgages.

The right ARM could increase the amount you qualify to finance or make it easier to buy when home prices are increasing.

If your household earnings are $6,000 a month, for instance, and your monthly property taxes and homeowners insurance equal $300 a month, most mortgage guidelines would allow you to spend up to $1,500 on your next home for principal and interest.

An ARM with a lower rate may allow you to qualify for a bigger loan. Here are a few examples, using actual rates from national sources as of this writing, for a $1500-per-month principal and interest payment:

ProgramRateLoan Amount
30 Yr Fixed4.250%$380,000
7/1 ARM4.000%$393,000
5/1 ARM3.875%$399,000
3/1 ARM4.125%$387,000

Note that 3-year ARMs are more expensive than their more stable counterparts, 5- and 7-year loans. In other markets, 3/1 ARM rates were the cheapest around. This could be that more consumers are choosing longer-term ARMs, so with volume come discounts.

Or it could be lenders’ way of discouraging this short-term, riskier loan type.

ARMs can affect your buying power

Understand, however, that various programs qualify ARM borrowers differently than they do fixed-rate borrowers.

FHA qualifies you at the note rate. Fannie Mae and Freddie Mac qualify 7/1 and 10/1 applicants at the note rate, but they might add two percent to the qualifying rate of a 3/1 applicant.

Still, other lenders use the “fully-indexed rate,” which is the rate your loan would be if it were adjusting today based on its terms. So if your 3/1 rate would reset to 3.5 if it were adjusting today, that might be your qualifying rate.

It all depends on the loan terms and the lender.

The ARM's moving parts: how they work together

ARMs operate differently than fixed-rate loans. There are a few factors that go into setting an ARM rate, so it’s important to understand what they are.

The ARM you choose is named for the way it works. For instance, a 5/1 ARM has a fixed rate and payment during its first five years, and then it resets annually, according to its terms.

Similarly, 10/1 ARM rates remain fixed for the first ten years of their terms.

Start rate

This may also be referred to as “teaser rate.” Without this lower start rate, no one would ever choose an ARM over a fixed rate. You’d be taking on extra risk without getting any reward.

The ARM’s lower start rate is your reward for taking some of the risk normally born by the lender — the chance that interest rates may rise a few years down the road.

In the example above, the start rate for the 5/1 ARM is 3.202 percent.

Fully-indexed rate

The “fully-indexed” rate is the interest rate that you’d pay once the start rate expires. However, this rate is subject to some limitations called “caps” and “floors.”

To calculate the fully-indexed rate, you add two figures — an index and a margin.

This rate is sometimes used by lenders to qualify you for your mortgage.

The index + the margin = your fully-indexed rate.


The index is a published measurement of financial activity. Here are some of the most common:

  • Constant Maturity Treasury (CMT or TCM)
  • Treasury Bill (T-Bill)
  • 12-Month Treasury Average (MTA or MAT)
  • Certificate of Deposit Index (CODI)
  • 11th District Cost of Funds Index (COFI)
  • Cost of Savings Index (COSI)
  • London Inter-Bank Offering Rates (LIBOR)
  • Bank Prime Loan (Prime Rate)

Movements in the index on which your ARM is based determine whether your rate increases or drops when it resets. The illustration below shows how some indexes have moved in the past.

When you choose an ARM, you and your lender agree on a margin. This is a percentage that’s added to the value of the index to calculate your fully-indexed rate.

Assume that you have a 3/1 ARM based on the 1-Year LIBOR index. Its rate has been fixed at 2.0 percent for the last three years, and now it’s resetting for the first time.

As of this writing, the one-year LIBOR rate is 1.71 percent.

If your margin is 2.5 percent, your loan’s fully-indexed rate is 1.71 + 2.5 percent or 4.21 percent.

But wait; there’s more. Your ARM probably has additional parameters called caps and floors, which limit the amount your interest rate can change.


Caps limit the amount your interest rate can increase. There are several kinds of caps. Often, ARMs have one cap that applies only to the first adjustment — for example, when your start rate expires.

Other caps apply to every year your loan is due for a reset or adjustment.

Finally, loans have lifetime caps. Lifetimes caps can be expressed as a specific interest rate — for instance, 7.5 percent. They may also be defined as a percentage over the start rate — for instance, five percent over your start rate.

In the above example, your 3/1 LIBOR ARM had a 2.0 percent start rate and a fully-indexed rate of 4.21 percent. But if its rate increase is capped at 2.0 percent, your new rate cannot exceed 4.0 percent.


Just as rate caps are put in place to protect borrowers, rate floors are there to protect lenders.

In the last few years, some indexes have dropped to the point that mortgage lenders wouldn’t even be able to cover their costs if their rates decreased too much.

If your mortgage has a floor of 2.0 percent, your interest rate will never drop below this, even if its fully-indexed rate is lower.

How to shop for an ARM

ARM rates are more complicated than those of fixed-rate mortgages, so shopping for them is a little different also.

The easiest way to shop for an ARM loan is to choose one with a start rate period comes close to the time in which you expect to own the home or have the loan.

If you do that, you can pretty much shop for the ARM in the same way that you’d compare fixed-rate home loans.

For instance, if you expect to own your house for three-to-five years, look for 3/1 and 5/1 ARMs. Decide how much you want to spend zero points, one point, etc., and see who offers the lowest rate for that cost. Alternatively, choose an interest rate — say 3.25 percent for a 3/1 or 3.625 percent for a 5/1, and see who charges less for it.

APR and ARM calculations

The best-laid plans can go awry, so it makes sense to see what your ARM would do if you have to hold onto it for an extra year or two. Shopping for ARMs can be tough because their annual percentage rates, or APRs, can be pretty useless.

For instance, the APR calculation for a 3/1 LIBOR ARM assumes that after the first three years, the loan increases to its fully-indexed rate, or rises as high as it’s allowed to under the loan’s terms until it hits the fully-indexed rate, and remains there for the remaining 27 years of its term.

Comparing ARM rates

A pretty unlikely scenario. In addition, you can only compare similar loans. So you can’t just look at two ARM APRs and assume the lower one is the better deal.

What you can do is compare each loan’s fully-indexed rate, and see what each would look like if it were resetting today. If you compare two 5/1 ARMs, for instance, both costing zero points and having 3.75 percent interest rates, the comparison might look something like this:

Loan A

  • 1-Year LIBOR Index: 1.71%
  • Lender Margin: 2.25%
  • Fully-indexed rate: 3.96%

Loan B

  • 11th District COFI Index: 0.599%
  • Lender Margin: 3.0%
  • Fully-indexed rate: 3.599%

What are today's mortgage rates?

Today’s ARM mortgage rates are still nice and low for homebuyers and for refinancing. The 3/1 and 5/1 products are still available at less than three percent for highly-qualified borrowers.

Talk to a skilled mortgage pro about selecting the right ARM loan for your circumstances.

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