The 2/28 Adjustable Rate Mortgage (ARM)

ELI5 Definition
Last updated: Jul 21, 2023

2/28 Adjustable Rate Mortgage (ARM)

The 2/28 Adjustable Rate Mortgage (ARM) is a financial instrument that has garnered significant attention in the realm of residential lending due to its unique structure and potential benefits for borrowers and lenders alike. In this article, we will delve into the intricacies of the 2/28 ARM, exploring its definition, mechanics, advantages, and potential risks. Understanding this financial product will empower prospective homeowners to make informed decisions when navigating the complex landscape of mortgage options.

💡 Key Ideas

  • Definition of 2/28 ARM: The 2/28 Adjustable Rate Mortgage is a mortgage product that offers a fixed interest rate for the first two years, followed by subsequent adjustments at regular intervals for the remaining 28 years.

  • Advantages: The 2/28 ARM provides lower initial interest rates, short-term payment stability, and potential for lower interest payments during the adjustable-rate phase.

  • Risks: The main risks associated with the 2/28 ARM include interest rate uncertainty, potential for higher future payments, and the possibility of payment shock when transitioning to the adjustable-rate phase.

Definition and Mechanics

The 2/28 ARM is a type of mortgage characterized by a fixed interest rate for the initial two years, followed by subsequent adjustments at regular intervals, typically every 12 months, for the remaining 28 years. Hence, the "2/28" notation refers to the two-year initial fixed-rate period and the subsequent 28-year adjustable-rate period.

During the fixed-rate period, borrowers benefit from a predictable and stable interest rate, which shields them from fluctuations in the broader financial markets. This feature is particularly attractive to homebuyers seeking short-term security and planning to refinance or relocate within the initial two years.

Upon the completion of the fixed-rate phase, the mortgage transitions into the adjustable-rate phase. During this period, the interest rate is recalibrated annually based on a predetermined index, such as the one-year Treasury index or the London Interbank Offered Rate (LIBOR), along with a predetermined margin, representing the lender's profit margin. The margin remains constant throughout the adjustable-rate period, while the index may fluctuate in response to changes in the broader economic landscape.


1. Lower Initial Rates

One of the primary advantages of the 2/28 ARM is its lower initial interest rate compared to traditional fixed-rate mortgages. This lower rate can facilitate homeownership for borrowers who may not qualify for higher fixed-rate mortgages, enabling them to enter the housing market with lower monthly payments during the initial two years.

2. Short-Term Flexibility

For individuals who anticipate changes in their financial situation, such as increased income or plans to relocate, the 2/28 ARM offers short-term flexibility. The fixed-rate phase allows borrowers to enjoy stable payments during the crucial early years of homeownership, after which they may have the flexibility to refinance or sell the property without being tied to a long-term commitment.

3. Potential for Lower Interest Payments

In scenarios where interest rates decrease or remain stable over time, borrowers may experience lower interest payments during the adjustable-rate phase compared to a traditional fixed-rate mortgage. This potential for decreased payments can lead to significant savings over the long term.


1. Interest Rate Uncertainty

The primary risk associated with the 2/28 ARM is the uncertainty regarding future interest rates. During the adjustable-rate phase, interest rates may rise, leading to higher monthly payments for borrowers. This escalation can result from changes in the underlying index, market fluctuations, or macroeconomic conditions. Consequently, borrowers must be prepared for the possibility of facing significantly higher interest rates than initially experienced.

2. Payment Shock

The transition from the fixed-rate period to the adjustable-rate period can lead to a phenomenon known as "payment shock." This occurs when the interest rate substantially increases after the initial fixed-rate period, resulting in a significant rise in monthly mortgage payments. Such an abrupt financial burden may strain borrowers who are unprepared for the potential payment increase.

Example: Evaluating the 2/28 ARM in Real Estate

To illustrate the workings of the 2/28 Adjustable Rate Mortgage, let's consider the hypothetical case of Mr. and Mrs. Johnson, a young couple aspiring to purchase their first home. The Johnsons have found a charming property priced at $400,000 and have decided to explore various mortgage options to finance their dream home. They are considering a 2/28 ARM and a traditional 30-year fixed-rate mortgage.

Mortgage Options:

1. 2/28 Adjustable Rate Mortgage

  • Initial Fixed-Rate Period: 2 years
  • Fixed Interest Rate: 3.5%
  • Adjustable-Rate Period: 28 years
  • Index: One-Year Treasury Index
  • Margin: 2.5%
  • Adjustment Frequency: Annually

2. 30-Year Fixed-Rate Mortgage

  • Fixed Interest Rate: 4.2%

Calculation and Comparison:

1. 2/28 ARM Calculation (Initial 2-Year Period):

During the initial fixed-rate phase, the Johnsons will have a fixed interest rate of 3.5%. Assuming they make a down payment of 20% ($80,000), the loan amount will be $320,000.

Monthly Payment Formula: P * (r / n) * [(1 + r / n)^(nt)] / [(1 + r / n)^(nt) - 1]

where, P = Loan Amount = $320,000 r = Monthly Interest Rate (Annual Rate / 12) = 3.5% / 12 = 0.0029167 n = Number of Payments per Year = 12 t = Total Number of Payments (2 years) = 2 * 12 = 24

Monthly Payment = $320,000 * (0.0029167) * [(1 + 0.0029167)^(122)] / [(1 + 0.0029167)^(122) - 1] ≈ $1,343.56

2. 30-Year Fixed-Rate Mortgage Calculation:

For the 30-year fixed-rate mortgage, the loan amount and monthly payment will be the same as above ($320,000 and $1,343.56) since we are comparing it with the initial 2-year fixed-rate period of the 2/28 ARM.

Analysis and Comparison:

The 2/28 ARM offers the Johnsons a lower initial monthly payment of approximately $1,343.56 during the first two years, whereas the 30-year fixed-rate mortgage would require the same amount. This difference of approximately $0.00 may seem marginal at first glance, but it could make a considerable impact on the Johnsons' financial planning during the initial period of homeownership.

Moreover, during the adjustable-rate phase, the Johnsons would face potential adjustments in their monthly payments based on the movement of the One-Year Treasury Index. If the index remains stable or decreases, they might benefit from lower interest rates and reduced monthly payments. However, if the index rises, their monthly payments could increase substantially, leading to potential financial strain.

Ultimately, the Johnsons must carefully weigh the advantages of the lower initial payments and short-term flexibility provided by the 2/28 ARM against the risks associated with the potential for payment adjustments in the future. They should also consider their financial goals, income stability, and long-term plans when deciding between the 2/28 ARM and the traditional 30-year fixed-rate mortgage. Seeking advice from a qualified financial advisor can be instrumental in making an informed and prudent decision.

Comparing the 2/28 ARM to a Fixed Rate Mortgage

To better understand the trade-offs between the 2/28 ARM and a traditional Fixed Rate Mortgage, let's conduct a comprehensive comparison of these two mortgage options. We will evaluate key factors such as initial interest rates, monthly payments, long-term stability, and flexibility. This analysis will assist potential borrowers, like the Johnsons, in making an informed decision regarding their preferred mortgage product.

Comparison Table:

Criteria2/28 ARMFixed Rate Mortgage
Initial Interest RateLower than fixed-rate mortgageFixed throughout the loan term
Monthly PaymentsLower during initial fixed periodConsistent throughout the loan term
Long-Term StabilitySubject to rate adjustmentsLocked at the initial rate
FlexibilityShort-term flexibilityLimited flexibility
Risk of Rate ChangesHigher potential for rate changesNo risk of rate changes
Refinancing OptionsPossible during fixed periodAvailable at current market rates
Ideal ForShort-term homeownership plansLong-term homeownership plans

Detailed Analysis:

  1. Initial Interest Rate: The 2/28 ARM typically offers a lower initial interest rate compared to a Fixed Rate Mortgage. This lower rate can result in lower monthly payments during the initial fixed-rate period, making the 2/28 ARM more attractive for borrowers seeking short-term cost savings.

  2. Monthly Payments: The 2/28 ARM's monthly payments are lower during the initial fixed-rate phase, providing borrowers with more affordable payments in the short term. However, once the adjustable-rate period begins, the monthly payments may fluctuate based on changes in the underlying index, potentially leading to higher payments.

  3. Long-Term Stability: The Fixed Rate Mortgage offers long-term stability as the interest rate remains constant throughout the loan term. Borrowers can rest assured that their monthly payments will remain unchanged, providing a sense of predictability and security.

  4. Flexibility: The 2/28 ARM provides short-term flexibility, allowing borrowers to enjoy lower payments during the initial fixed-rate period. This flexibility can be advantageous for individuals with temporary financial constraints or those who plan to sell or refinance the property within the first two years.

  5. Risk of Rate Changes: The main risk with the 2/28 ARM is the potential for rate adjustments during the adjustable-rate phase. If interest rates rise, borrowers may face significantly higher monthly payments, potentially causing financial strain.

  6. Refinancing Options: Borrowers with a 2/28 ARM have the option to refinance during the initial fixed-rate period, which can be beneficial if interest rates have dropped or their financial situation has improved. In contrast, borrowers with a Fixed Rate Mortgage would need to refinance at current market rates.

  7. Ideal For: The 2/28 ARM is ideal for borrowers with short-term homeownership plans, such as those who anticipate relocating or refinancing within the first two years. On the other hand, the Fixed Rate Mortgage suits individuals seeking long-term stability and predictable payments over the entire loan term.

In conclusion, the choice between a 2/28 ARM and a Fixed Rate Mortgage hinges on individual circumstances and financial goals. The 2/28 ARM offers initial cost savings and short-term flexibility, making it attractive for borrowers with specific homeownership plans. However, it also carries the risk of rate adjustments in the future, which could lead to higher monthly payments. On the other hand, the Fixed Rate Mortgage provides long-term stability and predictability, but it may not be as suitable for those seeking immediate cost savings or who plan to sell or refinance in the short term. Careful consideration of personal financial circumstances and future plans is crucial when selecting the most appropriate mortgage product. Seeking guidance from a qualified mortgage professional can help ensure an informed decision that aligns with the borrower's unique needs.


The 2/28 Adjustable Rate Mortgage presents a compelling mortgage option for certain homebuyers, particularly those seeking short-term stability and flexibility. By providing lower initial rates and short-term predictability, the 2/28 ARM allows borrowers to navigate the early years of homeownership with greater ease. However, borrowers must be cautious of the inherent risks associated with potential interest rate fluctuations, which could lead to higher payments in the future. As with any financial decision, prudence and careful consideration of individual circumstances are crucial when evaluating the suitability of the 2/28 ARM.