10/1 ARM

A 10/1 ARM is a mortgage product every homebuyer should know about. Bankrate explains it.

What is a 10/1 ARM?

An adjustable-rate mortgage, also known as an ARM, allows the homebuyer to keep the same interest rate for a certain amount of time. With a 10/1 ARM, the interest rate stays the same for 10 years. At the end of the 10 year ARM, the interest rate can go up or down each year, depending on the market, but the rate can be reset only once a year.

Deeper definition

Once it is time to adjust the rate on your 10 year ARM, lenders tend to use two numbers: the index and the margin.

  • The index is a general indicator of the housing market, which changes according to factors such as the number of prospective home sales and conditions of the market as rated by the National Association of Home Builders.
  • Margin: The margin is what is added to the index to cover the lender’s fees. The margin is set when you apply for the mortgage and stays the same throughout the life of the loan. The margin is determined by individual lenders.

The lenders add the current market index number to the margin to get the amount of the rate increase.

When it comes to an ARM, there are certain advantages and disadvantages. The biggest advantage to an ARM includes the fact that the initial interest rate is generally lower than a comparable fixed-rate mortgage. In addition, depending on the market, the interest rate can go even lower after the introductory period. The unpredictability of the market can also cause interest rates to climb, driving up your monthly payments.

Unlike a fixed-rate mortgage, which stays the same over the life of the loan, an ARM is at the whim of the housing market.

Example of a 10/1 ARM

If you take out a $300,000 mortgage using a 10/1 ARM, your monthly mortgage payment (principal and interest only), using Bankrate’s latest weekly average for that product (3.64 percent), would be $1,371 for the first 10 years. After that, your interest rate would reset every year for the life of the loan. Lenders use different indexes to calculate variable-rate loans, such as the London Interbank Offered Rate (LIBOR) or the Cost of Funds Index (COFI).

By comparison, the monthly payment on a $300,000 home loan with a conventional 30-year fixed-rate mortgage, using Bankrate’s latest weekly average of 4.04 percent, would be $1,439 for the life of the loan.

There are ARMs with different fixed-rate periods. The most common is the 5/1 ARM, which allows you to keep the same rate for five years. There are also 3/1 ARMs and 7/1 ARMs.

Use our free calculator to figure your monthly mortgage payment.

More From Bankrate