What Is a 10/1 ARM and How Does It Work?
Demystify the 10/1 ARM. Understand how this specific adjustable-rate mortgage works, its unique structure, and what it means for your home loan.
A 10/1 Adjustable-Rate Mortgage (ARM) is a type of home loan that blends fixed-rate and adjustable-rate mortgage characteristics. The interest rate remains constant for an initial period, then changes periodically for the remaining loan term. This hybrid structure offers a balance between payment stability and potential rate adjustments based on market conditions.
Understanding Adjustable-Rate Mortgages
An Adjustable-Rate Mortgage (ARM) is a loan where the interest rate applied to the outstanding balance can vary throughout its life. In contrast, a fixed-rate mortgage’s interest rate remains the same for the entire loan duration.
Components of an ARM Rate
An ARM’s rate is determined by two primary components: an index and a margin. The index acts as a benchmark rate that fluctuates with general market conditions. Lenders add a fixed percentage, known as the margin, to the index rate to calculate the interest rate. This sum of the index and the margin is called the fully indexed rate.
The margin is established at loan origination and remains constant throughout the mortgage’s life. Common indices used for ARMs include the Secured Overnight Financing Rate (SOFR) and the Constant Maturity Treasury (CMT). SOFR has largely replaced the London Interbank Offered Rate (LIBOR) as a primary benchmark.
Decoding the 10/1 Structure
The “10” in a 10/1 ARM signifies an initial fixed-rate period of ten years. During this time, the interest rate remains constant, providing predictable monthly payments. This stability allows for more consistent financial planning during the first phase of the loan.
The “1” indicates that after the initial ten-year fixed period, the interest rate adjusts annually. The rate can change once every 12 months for the remainder of the loan term, typically 20 years for a 30-year mortgage. At each adjustment, the new rate is determined by the current index value plus the predetermined margin.
Key Features of 10/1 ARMs
The margin for a 10/1 ARM, the lender’s fixed percentage added to the index, is determined at loan origination and typically falls within a range of 2.75% to 3%. This margin remains unchanged throughout the mortgage’s duration.
10/1 ARMs include interest rate caps that limit how much the rate can change. An initial adjustment cap restricts the first rate change after the fixed period, often set at 2% or 5%. Subsequent adjustments are limited by a periodic cap, commonly 1% or 2%. A lifetime cap establishes the absolute maximum interest rate that can be charged over the entire loan term, frequently set at 5% or 6% above the initial rate.
As the interest rate adjusts, the monthly mortgage payment changes. This recalculation considers the new interest rate and the remaining principal balance of the loan.