The First 10 Years

• The "10" in "10/1" means the loan has a fixed interest rate and payment for the first 10 years of the loan. For example, a 10/1 ARM with a 6 percent fixed interest rate and a $1,500 monthly payment would have that same rate and payment for the first 10 years of the loan. The initial fixed interest rate is based on factors such as a borrower's credit history, loan amount and property value.
  
  

After the 10th Year

• The first rate and payment adjustment occurs at the beginning of the 11th year. The "1" in "10/1" designates the adjustment interval of once per year. The payment is calculated based on the interest rate, which is based on an interest rate index, such as the London Interbank Offered Rate (LIBOR), and a margin added to the index. For example, a 3 percent LIBOR index and a 2 percent margin would result in a 5 percent interest rate. The index fluctuates with the economy, and the margin is fixed based on a borrower's credit record.
  
  

Interest Rate Caps

• To protect a borrower from large swings in the payment adjustment, 10/1 ARMs typically have maximum amounts the interest rate can change. There is typically a cap on the first interest rate adjustment, a cap on each subsequent adjustment and a lifetime cap that limits the interest rate during the life of the loan. An interest rate increase higher than the cap for a particular adjustment period may carry over to a future adjustment period.
  
  

Advantages and Disadvantages

• A 10/1 ARM typically has a lower initial fixed interest rate than a 30-year fixed-rate mortgage, which could benefit a borrower who likes the stability of a fixed mortgage payment but plans to either move or refinance before the rate becomes adjustable. The lower initial rate may allow a borrower to qualify for a large loan amount, but a borrower who remains in the loan after the fixed-rate period may have trouble making loan payments if interest rates quickly rise, which is called payment shock.