ARM vs Fixed Mortgage Calculator
Model the worst case the caps allow, not the teaser rate
An ARM vs fixed calculator that models the worst case your rate caps actually allow, rather than the teaser rate you were quoted.
How this is calculated
An adjustable-rate mortgage offers a lower rate for an initial fixed period — five, seven or ten years — after which it resets annually to the index plus a margin, bounded by three caps. A 2/2/5 structure means the first adjustment can move at most 2 points, each later adjustment at most 2 points, and the rate can never exceed the initial rate by more than 5 points.
The caps are the only guarantee you have. The index is not knowable, so the honest way to evaluate an ARM is to model the worst case the caps permit and ask whether you could carry that payment. If the answer is no, the initial saving is not the relevant number.
firstReset = clamp(index + margin, initial − capInitial, initial + capInitial)
laterReset = clamp(index + margin, previous − capPeriodic, previous + capPeriodic)
ceiling = initialRate + capLifetime
appliedRate = min(computedRate, ceiling)
Re-amortize the remaining balance at each new rate.
Worst case: every adjustment moves the maximum allowed, up to the ceiling.
Worked example
A 5/1 ARM at 6.0% with 2/2/5 caps and a 2.75% margin.
When an ARM genuinely makes sense
The case is strongest when your horizon is shorter than the fixed period. If you know you are moving in four years, a 5/1 ARM is simply a cheaper fixed-rate loan for your actual holding period — the adjustment never happens. Military postings, planned relocations and a firm intention to trade up are all legitimate reasons.
The plan that is not a plan
"I will refinance before it adjusts" is the assumption that broke a great many households. Refinancing requires that rates are favorable, that your credit and income still qualify, and that the property still appraises. All three can fail at once, and they are most likely to fail in exactly the conditions that would make you want to refinance.
Read the caps carefully
A 5/2/5 structure is materially riskier than 2/2/5 — the first adjustment can jump five points rather than two. Some ARMs also carry a rate floor, meaning the rate cannot fall below a set level even if the index collapses. The caps and floor are in the note, and they are the part worth reading twice.