Question 1

What is the fully-indexed rate on an ARM?

Accepted Answer

The fully-indexed rate (FIR) is the sum of the ARM's index and its margin: Fully-Indexed Rate = Index + Margin. The index (such as SOFR or the CMT) moves with the market. The margin is a fixed number of percentage points set in the note and does not change over the life of the loan. At each adjustment, the new rate is based on the current index plus that fixed margin, then constrained by the rate caps.

Question 2

What do the three ARM caps do?

Accepted Answer

ARM caps limit how much the rate can move. (1) The initial (first-adjustment) cap limits the change at the very first adjustment. (2) The periodic (per-adjustment) cap limits how much the rate can move at each subsequent adjustment. (3) The lifetime cap sets the maximum rate over the entire loan term. Caps are often written as a set of numbers like 2/2/5 — meaning 2% initial, 2% periodic, 5% lifetime.

Question 3

How do you calculate a new ARM rate at adjustment?

Accepted Answer

First compute the fully-indexed rate (index + margin). Then compare it to the caps: the new rate cannot rise (or, for a decrease, fall) more than the applicable cap allows from the current rate, and it can never exceed the lifetime cap (or a floor, if one applies). The new rate is the fully-indexed rate limited by whichever cap binds. If the fully-indexed rate is within all caps, the new rate simply equals the fully-indexed rate.

Question 4

What is the difference between the index and the margin?

Accepted Answer

The index is a published, market-driven benchmark rate that changes over time — the lender does not control it. The margin is a fixed spread, set at origination, that the lender adds to the index to determine the borrower's rate. Because the margin is constant, ARM rate changes are driven entirely by movement in the index. NMLS exam questions frequently test that the margin never changes.

Question 5

What is a teaser rate, and why can the rate jump at first adjustment?

Accepted Answer

A teaser (or start) rate is a discounted initial rate that is lower than the fully-indexed rate. When the fixed-rate period ends, the rate resets toward the fully-indexed rate. Because the start rate was artificially low, the first adjustment can produce a large jump — limited only by the initial cap. This 'payment shock' at first adjustment is a classic consumer-protection and NMLS exam topic.

ARM Adjustment Calculator

ARM Adjustment Calculator

Worked Example

ARM Adjustments — Frequently Asked Questions

Practice 5 MLO / NMLS exam questions