What is a 10/1 ARM? A simple guide to adjustable-rate mortgages

A 10/1 adjustable-rate mortgage has a fixed interest rate for the first 10 years. Then the loan's rate changes, once a year, for the remaining 20 years of the loan.

When the loan's rate changes, the new rate will reflect market conditions at that time. That means the new rate could go up or down.

The loan's monthly payments will change when the rate changes.

What is a 10/1 ARM?

The numbers tell the story:

• 10: The length of a 10/1 ARM's introductory rate.
• 1: The length of each additional rate.

During the first decade of the 30-year loan term, the loan behaves like a fixed-rate mortgage. The rate won't change, and the amount due for principal and interest payments won't change either.

After the first 10 years, the loan's rate will change once a year. If market rates are higher when the loan's rate changes, the 10/1 ARM's rate will increase. If market rates have decreased, the 10/1 ARM's rate will decrease.

How does a 10-year adjustable-rate mortgage work?

The housing market crash back in 2008 gave adjustable-rate mortgages a bad name, but modern ARMs offer more guardrails to help protect borrowers from out-of-control rate fluctuations.

The 10/1 ARM calculates rates by combining two numbers:

• An index rate
• A margin rate

The index changes with market conditions, while the margin stays the same.

This formula creates your new rate:

Index + Margin = Your Interest Rate (within limits set by rate caps)

Where does an ARM's index rate come from?

Lenders use different index rates. Common options include the Secured Overnight Financing Rate (SOFR), Constant Maturity Treasury (CMT) rate, or U.S. prime rate.

Where does an ARM's margin rate come from?

The margin varies by borrower and lender. Borrowers with the best qualifications tend to pay smaller margin rates.

What are an ARM's rate caps?

Rate caps protect ARM borrowers from dramatic increases regardless of what happens to the index rate.

These caps appear as three numbers, like 2/2/5:

• First number: Maximum increase at the ARM's first adjustment
• Second number: Maximum increase for subsequent adjustments
• Third number: Lifetime cap on the ARM's interest rate

So, let's say you get a 10/1 ARM with an intro rate of 5.5%. With a rate cap of 2/2/5, the ARM's rate could not exceed 7.5% at its first adjustment, even if market rates had increased by more than 2%. The loan's rate couldn't exceed 9.5% at its next adjustment, and the rate could never exceed 10.5%.

Understandably, most homeowners would rather not pay 10.5% on a mortgage for any reason, but that's the maximum possible rate. ARM rates can also decrease as market rates decrease. They'll never go lower than the loan's margin rate.

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10/1 ARM vs. other loan types

Comparing different mortgage types helps borrowers find the best loan for their unique needs.

Here's how the 10/1 ARM measures against similar products:

10/1 vs 10/6

Both of these ARMs offer 10-year fixed periods, creating a decade of stable payments. The difference comes into play after this initial period ends. A 10/1 ARM adjusts once a year, while a 10/6 ARM adjusts every six months.

With a 10/6 ARM, you'd experience twice as many rate adjustments throughout the remaining loan term. Rising market rates could push a 10/6 ARM up faster than its 10/1 counterpart. Falling rates might benefit the 10/6 ARM with more frequent decreases.

10/1 vs 5/1 loans

The fixed-rate period separates these adjustable-rate mortgages. A 5/1 ARM locks your rate for five years before annual adjustments begin, while a 10/1 ARM provides a fixed rate for a full decade.

Most 10/1 ARMs carry slightly higher initial rates than 5/1 ARMs since the rate lock lasts twice as long. 

10/1 vs 30-year fixed mortgage

A 30-year fixed-rate mortgage keeps the same rate for the entire 30-year loan term. The principal and interest payment on this loan won't change. (The mortgage payment could increase because of property tax or homeowners insurance increases.)

Let's consider the principal and interest payments: a 10/1 ARM might offer 5.5% initially compared to 6.5% for a 30-year fixed mortgage. On a $400,000 loan, the principal and interest due each month would be:

• $2,528 for the 30-year fixed
• $2,271 for the 10/1 ARM

That's a difference of $257 per month, and a savings of about $30,800 over 10 years.

Someone who's planning to sell or refinance within the first 10 years may like this deal. For long-term homeownership, the fixed-rate option protects against potential rate increases.

More about 10/1 ARM vs 30-year fixed

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10/1 ARM pros and cons

10/1 adjustable-rate mortgages work best for borrowers who can take advantage of the loan's pros without experiencing too many of its cons.

10/1 ARM pros

• Lower initial interest rate: A 10/1 ARM typically beats a 30-year fixed-rate mortgage on starting rates, cutting your monthly payments during the first decade. 
• Increased borrowing power: Lower initial rates could help you afford a larger home or better location than you might otherwise qualify for.
• Extended stability period: Ten years of predictable payments gives you twice the stability of a 5/1 ARM. This decade provides ample time to establish yourself financially.
• Potential for lower payments: Should interest rates decline when your fixed period ends, your monthly payment could decrease, offering additional savings.
• Rate cap protection: Most 10/1 ARMs include caps that limit how much your interest can increase at each adjustment.

10/1 ARM cons

• Higher payments possible: Market rate increases after the fixed period could push your payments higher. This uncertainty makes long-term financial planning challenging.
• Complexity: Adjustable-rate mortgages have more moving parts than conventional loans with fixed rates. Understanding indexes, margins, and adjustment caps may take more time.
• Potential prepayment penalties: Some lenders might charge fees if you refinance before the adjustment period begins.
• Risk of negative equity: If home values declined dramatically, you could owe more than your home's worth, especially with interest-only ARMs whose regular payments don't reduce the loan's principal.
• Stricter qualification rules: Qualifying for a 10/1 ARM can be harder than fixed-rate options. You may need a higher down payment (at least 5%) and meet stricter credit score, income, and debt-to-income ratio requirements.

When should you consider a 10/1 ARM?

Your plans for the new home should guide whether a 10/1 ARM makes sense for you.

An ARM may be worth considering if:

You're planning to sell within 10 years

Homeowners planning to sell or refinance within 10 years could benefit most from a 10/1 ARM. You'd save from the initial lower interest rate without ever experiencing a rate change. But keep in mind plans could change, requiring a refinance to avoid a rate shift.

You expect income growth in the next 10 years

Income trajectory affects ARM borrowing. If you expect substantial income growth over the next decade, you'd handle potential rate increases better if you stay longer than planned. That's why first-time homebuyers with strong career advancement prospects often choose this loan structure.

You're buying in a high-interest rate environment

Higher interest rate environments make a 10/1 ARM more attractive. You can save initially, plus rates could fall before the rate adjusts.

You're comfortable with uncertainty

Even personality plays a role in whether a borrower should choose an ARM. The ideal 10/1 ARM borrower is willing to trade some uncertainty for some potential savings.

Take control of your mortgage decision

Most new homeowners prefer the stability of a 30-year fixed-rate mortgage because they can make payments without having to think about upcoming changes to their payment amount.

But adjustable-rate loans have their place. They're strategic tools that, when used deliberately, can save money.

Regardless of what loan type you'd prefer, a mortgage pre-approval is a good starting point for the journey.

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