Adjustable Rate Mortgages in California
ARMs get a bad reputation. Most people remember 2008. Adjustable rates gone wild. Payment shock. Foreclosures. Families losing homes.
I was there. Saw it firsthand. 2006-2008 was brutal. People getting 2/28 ARMs with teaser rates. No income verification. Rates jumping 4% to 5% after two years. Payments doubling. Disaster.
Modern ARMs? Completely different animal. Built-in rate caps. Strict consumer protections. Lower initial payments with hard limits on how much rates can climb. Dodd-Frank changed everything. Qualified Mortgage rules. Ability-to-repay requirements. Can’t happen again.
Planning to move in 5 to 7 years? Need lower payments to qualify? ARMs make sense. Always have. Just need the protections.
Fixed rate at 6.5% too high? 5/1 ARM might start at 5.75%. That’s real savings during the fixed period. On a $700k loan, that’s $4,423 monthly versus $4,164 monthly. Save $259 monthly for five years. That’s $15,540 saved. And you’re protected by caps if you stay longer. Worst case? Rate goes to 7.75% at year six. Still capped. Still manageable if you qualified properly.
How ARMs Work
Two phases:
Phase 1 – Fixed period (3, 5, 7, or 10 years) Payment stays the same. Works exactly like a fixed-rate mortgage. No adjustments.
Phase 2 – Adjustment period (after fixed period) Rate adjusts yearly based on market. But caps limit changes.
The math: Index + Margin = Your new rate (subject to caps)
- Index: Market rate (SOFR usually)
- Margin: Fixed at closing (2% to 3% typical)
- Caps: Protect you from huge jumps
Rate Caps Protect You
This is what makes ARMs safe. You know your maximum exposure. Can’t get blindsided.
Typical 2/2/5 cap structure:
- Initial cap: 2% max at first adjustment
- Periodic cap: 2% max per year after that
- Lifetime cap: 5% max total increase
Start at 5.5%? Your rate can never go above 10.5%. Ever. No matter what happens. Rates hit 15%? You’re capped at 10.5%. That’s the law. Built into the loan documents. Non-negotiable.
Had a client with 5/1 ARM at 4.25% back in 2018. Five years later (2023), market rates hit 7%. His ARM adjusted to 6.25% (2% initial cap applied). Saved him versus refinancing. Refinancing would’ve been 7% plus closing costs. Staying with the ARM was cheaper even with the adjustment.
Another client got a 7/1 ARM at 3.5% in 2016. Still in his fixed period until 2023. When rates spiked, he was protected. Selling the house in 2024. Never experienced a single rate adjustment. Saved $250 monthly versus fixed for eight years. That’s $24,000 saved total. Took his family to Europe twice with the savings. That’s what ARMs can do when you use them right.
ARM Types
5/1 ARM – Fixed 5 years, adjusts yearly after. Most popular. Best for 5 to 7-year ownership.
7/1 ARM – Fixed 7 years, adjusts yearly after. More stability. Slightly higher initial rate.
10/1 ARM – Fixed 10 years, adjusts yearly after. Maximum protection. Rate closer to fixed.
ARM vs Fixed Rate
Pick ARM if:
- Moving in 5 to 10 years
- Need lower payments to qualify
- Think rates will drop
- Want maximum buying power now
Pick fixed if:
- Staying 10+ years
- Want payment certainty
- Can afford higher initial payment
- Hate uncertainty
Neither’s wrong. Match the loan to your plan.
Why ARMs Work in California
Buying power – Lower payment might qualify you for $50k to $100k more house. Real example: Client couple making $150k yearly. With 6.5% fixed, qualified for $625k. With 5.75% ARM, qualified for $675k. That extra $50k opened up different neighborhoods. Better schools. Nicer homes. Made the difference.
Market timing – Buying during high rates? ARM provides relief during fixed period. When rates hit 7% in 2023, ARM buyers got 6% to 6.25%. Saved money. If rates drop (and they will eventually), they refinance. If rates stay high, they still saved during the fixed period.
Move-up strategy – Planning to upgrade in 5 to 7 years? Perfect fit. Starter home buyers love ARMs. Save money on the payment. Build equity faster with extra principal payments. Sell before adjustment. Move into forever home. Rinse and repeat.
Had a young couple buy a condo with 5/1 ARM at 4.5% in 2019. Saved versus fixed. Four years later, sold for $150k profit. Never saw an adjustment. Used the equity for down payment on a house. That ARM strategy worked perfectly.
Cash flow – More money monthly for life, investments, kids. That $200 to $300 monthly savings? Invest it. S&P 500 average return is 10% yearly. $250 monthly invested at 10% for five years? $19,407. You just created wealth by picking ARM over fixed.
25,000 ARM loans close yearly in California. Usage jumps when fixed rates climb. 2021? ARMs were 3% of loans. 2023? 15% of loans. People aren’t dumb. They know how to save money. Currently 10% to 15% of purchase loans depending on rate environment.
Smart Strategies
Starter home play – Buy with ARM. Build equity 5 to 7 years. Sell and move up. Lower payments during wealth-building phase.
Rate bet – Think rates will drop? ARM benefits automatically when they do. No refinance needed.
Life stage match – Know you’ll move? Growing family, career change, retirement plans. ARM fits changing needs.
Qualifying for ARMs
Higher standards – Lenders qualify you on the adjusted payment, not just initial rate. Protects everyone.
Same docs – Income, employment, assets, credit. No different than fixed rate.
Can lock rate – Initial ARM rate locks just like fixed. Protected during buying process.
Worried about qualifying? Call us. (510) 589-4096. We work with ARM specialists who know the workarounds.
Safety Tips
Know your caps – Understand maximum payment. Budget for worst case.
Plan exit – What’s the strategy? Sell, refinance, or ride it out?
Monitor rates – Check your index a year before first adjustment. No surprises.
Build equity – Extra principal payments during fixed period. Lower balance = lower adjusted payments later.
Loan Limits
Same limits as conforming loans:
Standard counties: $806,500 max High-cost counties: $1,209,750 max Jumbo ARMs: Above conforming limits, slightly different terms
Myths About ARMs
“ARMs are risky” – Rate caps limit exposure. Fixed period gives years of predictable payments.
“Payments always go up” – Can go up OR down. Depends on market rates. Plenty of ARM borrowers see decreases.
“Banks trick you” – Disclosure laws are strict. You know exactly how your ARM works before signing.
Bottom Line
ARMs aren’t villains. With rate caps, they’re safe for the right situation.
Planning to move in 5 to 7 years? ARM saves money. Staying 15 years? Fixed makes more sense.
Honest questions to ask:
- How long will I stay?
- Can I handle potential increases?
- Do I need lower payment to qualify?
Answer honestly. You’ll know if ARM fits. Check our FAQ for more questions.