Short answer: rate caps limit how much the interest rate on an adjustable-rate mortgage (ARM) can change. A cap written as 2/1/5 means the rate can move no more than 2 percentage points at the first adjustment, no more than 1 point at each adjustment after that, and never more than 5 points above the starting rate over the life of the loan. Caps work in both directions on most conventional ARMs, limiting decreases as well as increases.
If you are comparing an ARM with a fixed-rate loan, the caps are the most important part of the fine print. Here is how to read them.
What is an adjustable-rate mortgage?
An ARM has a fixed rate for an initial period, then adjusts on a set schedule. The name tells you both numbers: a 5/6 ARM is fixed for five years and then adjusts every six months. Most conventional ARMs today are SOFR ARMs, which use the 30-day average of the Secured Overnight Financing Rate (SOFR) as their index. Our adjustable-rate mortgage page covers when an ARM can make sense.
How is the new rate calculated after the fixed period?
At each adjustment, the new rate equals the index plus the margin, limited by the caps.
- Index: a market rate that moves over time, such as 30-day average SOFR.
- Margin: a fixed number of percentage points set in your loan documents. It does not change.
- Caps: the limits on how far the rate can move at each change and over the life of the loan.
If index plus margin would move the rate further than a cap allows, the cap wins.
What do the three cap numbers mean?
| Cap | What it limits |
|---|---|
| Initial adjustment cap | The most the rate can change at the first adjustment after the fixed period ends. |
| Subsequent (periodic) cap | The most the rate can change at each later adjustment. |
| Lifetime cap | The most the rate can ever rise above the starting rate. |
Which caps come with common conventional ARMs?
Freddie Mac’s SOFR ARM products use these standard caps:
| ARM | Fixed period | Adjusts | Caps |
|---|---|---|---|
| 3/6 SOFR ARM | 3 years | Every 6 months | 2/1/5 |
| 5/6 SOFR ARM | 5 years | Every 6 months | 2/1/5 |
| 7/6 SOFR ARM | 7 years | Every 6 months | 5/1/5 |
| 10/6 SOFR ARM | 10 years | Every 6 months | 5/1/5 |
Notice that the longer fixed periods allow a larger first adjustment. The lifetime cap is the same, so the worst case is the same, but it can arrive sooner after the fixed period ends. Jumbo and non-QM ARMs can use different caps, so always check the specific program.
How do caps limit the rate in practice?
Take a 5/6 ARM with 2/1/5 caps. At the first adjustment, right after the five-year fixed period ends, the rate can be no more than 2 points above the starting rate. Every six months after that it can move up or down by at most 1 point. And no matter what the index does, the rate can never be more than 5 points above where it started.
That lifetime cap is the number to plan around. Ask your loan officer to show you the payment at the fully capped rate, so you know the most it could ever be.
Where do I find the caps on my Loan Estimate?
Page 2 of the Loan Estimate includes an Adjustable Interest Rate (AIR) Table listing the index, margin, first change, subsequent changes and limits. Page 1 shows whether the rate and payment can increase and the highest they can reach. Our mortgage glossary explains every term on the form.
Who might consider an ARM?
- Buyers who expect to sell or refinance before the fixed period ends.
- Borrowers who want a lower initial rate than a comparable fixed loan and can absorb the capped worst case.
- Jumbo borrowers, where ARM pricing is sometimes more competitive.
An ARM is a poor fit if the payment at the lifetime cap would strain your budget. A fixed-rate loan trades a possibly higher starting rate for certainty.
Your Eureka moment
ARMs feel risky because the future rate is unknown. Seeing the worst-case payment written down, next to the fixed-rate option and your plans for the home, turns an open-ended worry into a defined trade-off you can actually evaluate.
What’s the next step?
Ask us to price a fixed loan and an ARM side by side, including the payment at the lifetime cap. We compare options from 25+ wholesale lenders. No consultation fees, ever. Connect with us.
Frequently Asked Questions
What does 2/1/5 mean on an ARM? The rate can change by up to 2 percentage points at the first adjustment, up to 1 point at each later adjustment, and can never rise more than 5 points above the starting rate.
How often does a SOFR ARM adjust? Conventional SOFR ARMs adjust every six months after the initial fixed period ends.
Can an ARM rate go down? Yes. If the index falls, the rate can decrease at an adjustment, generally within the same caps, but usually not below the margin or a floor stated in your note.
What is the margin on an ARM? The margin is a fixed number of percentage points added to the index to set your rate at each adjustment. It is set at closing and does not change.
Where are ARM caps disclosed? In the Adjustable Interest Rate (AIR) Table on page 2 of your Loan Estimate, and in your note at closing.