A 10/1 ARM loan is an adjustable-rate mortgage that has a fixed rate for its first 10 years. After that, its interest rate adjusts one time per year. Loans with adjustable rates expose you to risk should rates rise. In exchange for taking on this risk, you as a borrower can get a lower rate and lower monthly payments during the initial fixed-rate period.
Most people who take out a loan to buy a home opt for a 30-year fixed-rate mortgage. Those who can afford a larger monthly payment may choose a 15-year loan term instead. By choosing loans with fixed rates, these buyers avoid the risk of increased monthly payments should rates rise.
In today’s low-interest-rate environment, preferring a fixed rate seems like common sense. For many mortgage borrowers, it may be just that. It is not the only option, though, and prudent homebuyers should try to know all their options before making a commitment.
Adjustable-rate mortgages, ARMs, offer an alternative to fixed-rate options like the 30-year fixed mortgage. One type of ARM is a 10/1 ARM.
What is a 10/1 ARM?
By convention, lenders identify ARMs using a shorthand of the form “A/B” where “A” is the number of years in the mortgage’s initial fixed-rate period and “B” is the adjustment interval or time between rate adjustments after the fixed-rate period ends. Each interval’s adjusted mortgage rate will be a benchmark rate, determined by an index, plus a margin, additional percentage points over the index rate. Both the margin and the index will be specified in the mortgage agreement.
One confusing thing about this shorthand is that the second number can be either a number of years or a number of months. So, a 10/1 ARM is a mortgage loan with an adjustment interval of one year. But a 10/6 ARM is a mortgage loan with an adjustment interval of six months.
Adjustable-rate mortgage benchmarks
One benchmark commonly used for ARMs has been the London Interbank Offered Rate (LIBOR). In 2018, the Federal Reserve Bank of New York indicated that $1.2 trillion worth of retail mortgages in the United States used LIBOR to set rates. Since no LIBOR index will remain after the middle of 2023, lenders will need to peg the rates for ARM loans to indexes based on some other benchmark. The Secured Overnight Financing Rate (SOFR) is the leading candidate to replace LIBOR as the go-to benchmark for ARMs.
Lower interest rate now, unknown interest rates later
So, a 10/1 ARM is an adjustable-rate mortgage where the annual percentage rate (APR), and so the monthly payment, will remain fixed for the first 10 years. After that, the APR will adjust once per year. The interest rate for the first 10 years will typically be lower than the rate for a 30-year fixed-rate mortgage. When borrowers choose a 10/1 ARM, that lower interest rate for the first 10 years will typically be why. The interest rate after that fixed period will depend on market forces the borrower can neither predict nor control. And so will the monthly payment.
Data on the average rates of 10/1 ARM mortgages is not available, but we do have good data on 5/1 ARM mortgages, which provide a good idea of the savings you can expect.
Keep caps in mind
As you figure out if an ARM is the right mortgage option for you, keep in mind that ARM rate adjustments will be capped. Your mortgage agreement will specify limits on how low or high your rate can go and how quickly.
A “cap” on the bottom to protect your bank
For instance, your ARM’s APR will normally have the margin, or some rate a little above that, set as its minimum. Even if the Federal Reserve decides to experiment with negative interest rates and your ARM’s benchmark follows suit, your ARM’s rate will never drop below this minimum.
Two caps on the top to protect you
Though minimums protect the interests of your lender, caps or maximums protect your interests. Your ARM mortgage agreement will probably specify both a lifetime rate (adjustment) cap and a periodic rate (adjustment) cap. The former limits how much your rate can rise over the entire term of the mortgage. The latter limits how much the rate can change in a single year.
10/1 ARM periodic rate cap
With a 10/1 ARM, the periodic rate cap means the yearly adjustment to your rate cannot exceed a certain amount. If rates shoot up more than this all at once, this gives you a year to sell or refinance your home before the following year’s adjustment permits another increase. It also gives rates a chance to drop back to a more reasonable level and save you the trouble.
This cap can be subdivided into two different periodic caps, an initial adjustment cap and a subsequent adjustment cap. The former specifies the maximum rate change the first time the rate adjusts. The latter limits the size of rate changes for every adjustment period after that.
10/1 ARM lifetime rate cap
In addition, the lifetime rate cap (lifetime adjustment cap) means that, no matter how high the benchmark rate becomes, no number of successive yearly adjustments can ever take your rate over the cap. If your mortgage agreement specifies this cap in terms of the adjustment size rather than the resulting rate, the cap will mean your combined adjustments can never add up to more than the cap.
How does a 10-year ARM work?
Now that you know the basics, you’re ready to examine 10/1 adjustable-rate mortgages more closely. If you’d like to know more about ARMs in general, read “What is an Adjustable-Rate Mortgage?”
ARMs’ future monthly payment challenge
As you might know, it’s pretty easy to get a rough idea of what your payments will look like over the course of a mortgage with a fixed APR. You just find an online mortgage payment calculator and run the numbers. But these mortgage calculators don’t do ARMs. Even Alliant Credit Union, a company with positive SuperMoney reviews (as of January 2022) that offers a 10/6 ARM, links an article on its adjustable-rate product to a mortgage calculator configured for fixed rates.
Your future monthly mortgage payment: Nothing to worry about?
Now, Alliant points out that (1) few borrowers keep a mortgage more than 10 years and (2) a majority of homebuyers move to a new home within 8 years. So, Alliant reasons, why worry about what might happen 10 years from now? Does Alliant have a point?
Perhaps. Still, you cannot say for certain that interest rates 10 years from now will not be going up. You also can’t say for certain that your credit will be as good then as it is today. What if interest rates start climbing and you can’t qualify for a refinance with appealing rates? What if home sales are also sluggish and you can’t get a satisfactory price selling?
In personal finance, ignorance is not bliss
Before you commit to an ARM, you should try to get some feel for what might happen if you have to stay with it till you get your home paid off. Hoping for the best will never hurt you. Preparing only for the best could hurt you a great deal.
Fortunately, the fixed-rate focus of the typical mortgage payment calculator doesn’t have to stop us from exploring some future possibilities. When your ARM’s introductory fixed-rate period ends and the first rate adjustment happens, what sort of higher mortgage payment can you expect? Let’s explore one possible future.
10/1 ARM example
One way to get some sample numbers is to use a fixed-rate calculator and treat each annual adjustment as a new fixed-rate mortgage lasting the remainder of the loan term. Basically, an ARM that adjusts once per year produces results resembling those you’d get if you refinanced your mortgage every year for a term one year shorter. The resemblance only holds if we assume no added fees and costs when refinancing, of course, but that’s sufficient for our purposes.
Some starting assumptions
A 10/1 ARM will typically be amortized over 15 or 30 years, just like a fixed-rate mortgage. We’ll assume a $250,000 loan with a 15-year term. To make calculator output more manageable, we’ll assume yearly payments. We’ll just divide these by 12 to get the approximate monthly mortgage payments.
For simplicity, we’ll disregard private mortgage insurance and property taxes. But be aware that these are not insignificant expenses.
- Private mortgage insurance, which protects the lender from loss should you default, could cost you from less than 1% to more than 2% of your loan balance each year. Mortgage providers often refer to this insurance by its acronym, PMI.
- Property taxes can also cost you a lot. On the positive side, the Brookings Institute indicates that most U.S. counties’ property taxes cost less than 1% of properties’ values. On the negative side, the Tax Foundation notes that property taxes vary widely. How widely? A study by the Lincoln Institute of Land Policy found a range of rates from 0.30% in Honolulu, Hawaii, to 3.88% in Bridgeport, Connecticut, in 2015.
To produce a table of values for our 15-year 10/1 ARM, we just need to combine the first 10 years of a 15-year fixed-rate mortgage with the first years of 5-year, 4-year, 3-year, 2-year, and 1-year fixed-rate mortgages, using the balance from the end of year one of each prior mortgage as the loan amount for the next.
The total term of our 10/1 ARM is 15 years. To figure out payments for the first 10 years, we just need to know the interest rate for the initial period. For years 11–15, we need to propose a plausible future interest rate and rate-change trajectory.
Low initial interest rate
According to Macrotrends, the average interest rate for a fixed 30-year mortgage was 3.56% when this article was prepared in January 2022. At that same time, US Bank quoted an ARM interest rate of 3.375% prior to fixed fees and other expenses, or an APR of 3.395% with such fees and expenses included. For simplicity, we’ll disregard this distinction between interest rate and total APR and do our calculations in terms of a single interest rate or APR. And we’ll use the terms interest rate and APR interchangeably.
For later comparison, we’ll assume an APR for fixed-rate mortgages of 3.6%, rounding up the real-world value for January 2022. Doing the same thing for our 15-year 10/1 ARM gives us an APR during the initial fixed period of 3.4%.
Rising mortgage rates later
For illustration, we’ll assume that the interest rate when you finish your fixed-rate period has risen 2%, to 5.4%, and that it continues to rise, but more slowly, at 0.1% each year thereafter.
Is an increase of 2% in the next 10 years likely? Well, a variation of 2% in rates within a 10 year period is not unheard of in recent times. According to Macrotrends, the range of 30-year fixed mortgage rates varied from a minimum of 2.67% to a maximum of 4.86% during the 10-year period starting in 2012.
Of course, this range owes to the high in 2018 followed by a plunge to the low in 2020. But rates that can plunge quickly should be able to rise just as quickly given the right circumstances. So, in theory, a 2% rise in just two years could occur in the right market conditions. A 2% rise over the next 10 years might not be the most probable future, but it’s neither impossible nor the worst that could happen.
To keep our hypothetical case from being too pessimistic, we’ll assume that the rate of increase slows to 0.1% per year after 10 years. To ensure it’s pessimistic enough to be instructive, we’ll ignore rate caps.
15-year 10/1 ARM schedule and how we get it
Before explaining how to create this hypothetical monthly payment schedule for the future, let’s see the results:
The last column of this table, “Source,” indicates where we get the values displayed. Here’s a summary of the process:
- For years 1–10 of our ARM, we copy the values for years 1–10 of a 15-year fixed-rate mortgage with a 3.4% APR matching our ARM’s initial interest rate. We use $250,000 as our loan amount for the calculator.
- For year 11 of our ARM, we copy the values for year one of a five-year fixed-APR home loan with a 5.4% APR, reflecting the rate increase we’ve assumed. What do we use as the loan figure for the mortgage calculator? We use the remaining balance from the prior step: $97,585.40.
- For year 12, we copy the values for year one of a four-year fixed-APR home loan with a 5.5% APR, reflecting the upward rate trajectory we’ve assumed. The loan size we enter into the mortgage calculator is the remaining balance from the prior step: $80,065.44.
- For year 13, we copy the values for year one of a three-year fixed-APR home loan with a 5.6% APR. We enter the remaining balance from the prior step, $61,626.81, into the calculator as the amount borrowed.
- For year 14, we copy the values for year one of a two-year fixed-APR home loan with a 5.7% APR. For the loan balance, we use the remaining balance of the prior step, which in this case is $42,193.14.
- In the final year of our 15-year ARM, we copy the values for the sole year of a one-year fixed-APR home loan with a 5.8% APR. For the loan balance, we use the remaining balance of the prior step, $21,681.16.
No doubt there are other ways to figure out the amortization for an ARM with speculative rates after the initial fixed-rate period. Because this one is pretty straightforward and uses easily accessible, and plentiful, online mortgage calculators, we’ve used it.
Now that our picture of a possible ARM future is complete, what can we do with it? Without something to compare it to, the numbers in our table don’t mean much. So let’s compare this ARM to a fixed-rate mortgage of the same duration.
Comparing a 10/1 ARM with a fixed-rate mortgage
When the going rate for average ARMs is 3.4% during the initial period, the rate for a fixed-rate mortgage will be around 3.6%. That, at least, is the differential we’ve assumed based on some January 2022 stats.
A $250,000 mortgage at 3.6% amortized over 15 years looks like this:
So, this fixed-APR alternative amortized over the same number of years as our hypothetical 10/1 ARM would cost you a total of $327,913.92, a savings of less than $2,000. Unless you can get a better than average deal on your fixed-APR mortgage, your savings over a 10/1 ARM won’t be great if rates fail to rise more than a couple tenths of a percent over the next 10 years. They also won’t be great if the competing 10/1 ARM has a lifetime cap of, say, 2%. Should rates fall, of course, the 10/1 ARM borrower could end up paying less in the end than you do.
Should you get a 10/1 ARM?
It appears from our hypothetical 10/1 ARM that someone who believes that interest rates won’t rise more than 2% in the next 10 years can feel safe trading yearly rate adjustments a decade in the future for lower monthly payments today. At the same time, the fixed-period ARM rates are not much lower on average than fixed rates for standard mortgages with 15 or 30 year terms as of January 2022. They’re a bit lower, but just a bit. Specifically, for loans amortized over 15 years:
$21,552.19 per year, or $1,796.02 per month, in the initial period of a 3.4% ARM
$21,860.92, or $1,821.74 per month, throughout the term of a fixed 3.6% mortgage.
Is the reduction in payments during the first 10 years worth the possible increase in overall cost and monthly payments after 10 years? If you can’t do better than a fixed-period ARM rate 0.2% below the fixed-rate mortgage APR, your savings in the first 10 years won’t be very large. And if you can’t handle the monthly obligation of the fixed 3.6% mortgage, reducing that obligation by less than $30 per month with a 3.4% ARM probably won’t solve your problem. This suggests that you shouldn’t be willing to take on more than a little risk in exchange for short-term savings.
10/1 ARM risks
In choosing a 10/1 ARM, you face the following risks:
- The risk that rates will rise more than a couple percent in the next 10 years
- The risk that you will not refinance or sell your home in the next 10 years
Making your decision
If, on the one hand, you think mortgage interest rates of 5–10% (or higher) are as possible now as they ever were, you may decide the marginal near-term savings an ARM offers aren’t worth the risk. If you believe this and believe that there’s a significant risk that you won’t be able to refinance your home at an appealing rate or sell your home at an appealing price over the next 10 years, accepting these risk for a decade of small payment reductions probably isn’t right for you. Of course, the right caps can greatly reduce the risk to you should interest rates rise.
If, on the other hand, you think rates of 5% and higher are a thing of the past, you don’t risk much by opting for an ARM. Of course, if your fixed-period rate for an ARM will only be 0.2% less than the rate you could get for a 15- or 30-year fixed-APR mortgage, you don’t reduce your first decade of payments all that much. If you can get a better initial rate, the potential to save money with an adjustable-rate loan could make the short-term savings more substantial.
- The main reasons borrowers choose adjustable-rate mortgages (ARMs) are:
- lower monthly payments during the fixed-rate period,
- easier approval.
- The fixed-rate period for a 10/1 ARM is 10 years.
- The adjustment intervals for a 10/1 ARM is one year, meaning rates will adjust yearly after the fixed-rate period.
- During the adjustable-rate period, the rate you pay is the index, determined by market conditions, plus the margin, set in your mortgage agreement.
- ARM minimums and caps reduce the risk posed by changing interest rates.
- Minimums protect borrowers.
- Caps protect you.
- As of January 2022, average ARM rates during the fixed-rate period are only slightly lower than average rates for fixed-rate mortgages. This makes finding and making a better-than-average deal essential if you want to save.
Frequently Asked Questions
No quite ready to start your loan search? This postscript will answer a few of the questions we here are SuperMoney hear most often. Perhaps one of these will help you decide what to do next.
Can you pay off a 10/1 ARM loan early?
If you have the money, you can pay off any mortgage early. If your mortgage agreement does not impose a prepayment penalty, paying it off early could be a great idea. And paying off your 10/1 ARM before the first rate adjustment kicks in could relieve your anxiety about rates.
Does a 10-year ARM make sense?
Lots of lenders and borrowers think so. But whether a 10-year ARM makes sense for you depends on your financial situation, future plans, and how you think interest rates will behave a decade from now.
Who is an ARM mortgage better for?
For whom are ARM loans (often, if redundantly, called ARM mortgages) a good idea? If lower rates and payments in the short term are your primary concern, you may want to look into an ARM. If you don’t think interest rates are likely to rise a great deal over the next 10 years, or in the five to 20 years after that, you may find an ARM worth considering.
Do you pay principal on an ARM?
ARMs are fully amortized home loans. Like fixed-rate loans for property, ARMs come with a payment schedule that will zero them out over the life of the loan. This means you pay both principal and interest every time you make a payment. The big difference between ARM payment schedules and fixed-rate schedules is that future scheduled payments can change every time the rate adjusts.
View Article Sources
- 10/6 ARM vs. 30-year fixed: Which mortgage is right for you? — Alliant Credit Union
- 30 Year Fixed Mortgage Rate — Historical Chart — Macrotrends
- 50-State Property Tax Comparison Study for Taxes Paid in 2015 — Lincoln Institute of Land Policy
- Consumer Handbook on Adjustable-Rate Mortgages — Consumer Financial Protection Bureau (CFPB)
- For an adjustable-rate mortgage (ARM), what are the index and margin, and how do they work? — CFPB
- Home Purchase Mortgages: Reviews & Comparisons — SuperMoney
- How Much Does Private Mortgage Insurance (PMI) Cost? — Experian
- Mortgage Brokers: Reviews & Comparisons — SuperMoney
- Residential Property Taxes in the United States — The Brookings Institution
- Second Report of the Alternative Reference Rates Committee — Federal Reserve Bank of New York
- The Definitive Guide to Mortgage Rates — SuperMoney
- Today’s 10/1 ARM rates — US Bank
- The LIBOR index for adjustable-rate loans is being discontinued: here’s what to watch for — CFPB
- Your home loan toolkit: a step-by-step guide — CFPB
- What Is a Balloon Mortgage? — SuperMoney
- What is an Adjustable-Rate Mortgage? — SuperMoney
- What is a prepayment penalty? — CFPB
- What is private mortgage insurance? — CFPB
- Which Places Pay the Most in Property Taxes? — Tax Foundation
- With an adjustable-rate mortgage (ARM), what are rate caps and how do they work? — CFPB