What Is a 10/6 Mortgage and How Does It Work?

While fixed-rate mortgages offer a consistent interest rate throughout their term, adjustable-rate mortgages (ARMs) feature an interest rate that can change over time in response to market conditions. This variability means that while initial payments might be lower, they can also fluctuate, potentially increasing or decreasing over the life of the loan.

Understanding the 10/6 Structure

A 10/6 adjustable-rate mortgage is a home loan with two distinct periods: an initial fixed-rate phase and a subsequent adjustable-rate phase. The “10” signifies the interest rate remains fixed for the first ten years, providing borrowers with consistent principal and interest payments.

Following this initial period, the “6” indicates the interest rate can adjust every six months for the remainder of the loan term. This structure is a hybrid ARM, combining elements of both fixed and adjustable-rate loans, allowing for initial payment stability before transitioning to a more dynamic rate environment.

The Fixed-Rate Phase

The fixed-rate phase of a 10/6 mortgage provides a decade of payment predictability. During this initial 10-year period, the interest rate remains constant. This stability ensures that the principal and interest portion of the monthly payment will not change, regardless of shifts in the broader financial markets. This fixed period can be advantageous for those who anticipate moving or refinancing before the adjustable phase begins.

The Adjustable-Rate Phase

After the initial 10-year fixed period, a 10/6 mortgage transitions into its adjustable-rate phase. The interest rate changes every six months, reflecting current market conditions. The new rate for each adjustment period is determined by adding a fixed percentage, known as the margin, to a fluctuating financial benchmark called an index.

Common indices for ARMs include the Secured Overnight Financing Rate (SOFR) or the Constant Maturity Treasury (CMT) rate. SOFR is based on interest rates banks charge each other for overnight borrowing, while CMT rates reflect the average yields of U.S. Treasury securities. The margin, which is a set percentage added by the lender, remains constant throughout the life of the loan. For instance, if the index is 4% and the margin is 2.5%, the new interest rate would be 6.5%.

To protect borrowers from excessive rate increases, ARMs include interest rate caps. An initial adjustment cap limits how much the interest rate can change at the first adjustment period after the fixed phase, often set at 2% or 5%. Periodic caps restrict the rate change from one adjustment period to the next, commonly 1% or 2%. A lifetime cap defines the maximum overall interest rate that can be charged over the entire loan term, usually 5% or 6% above the initial rate. These caps provide boundaries for potential rate fluctuations.

Payment Dynamics and Recalculation

The transition from the fixed-rate phase to the adjustable-rate phase impacts monthly mortgage payments. During the initial 10 years, principal and interest payments remain stable, offering a consistent financial obligation.

Once the adjustable phase begins, the monthly payment is recalculated every six months based on the new interest rate, remaining loan balance, and term. If the index rate rises and caps allow, the interest rate will increase, leading to higher monthly payments. Conversely, if the index rate falls, the interest rate will decrease, resulting in lower monthly payments. This variability requires borrowers to be prepared for potential changes in housing expenses.