What is a 2/28 ARM (adjustable-rate mortgage)?
– A 2/28 ARM is a 30-year home loan that gives you a fixed interest rate for the first two years, then switches to an adjustable (floating) rate for the remaining 28 years. The adjustable rate equals a public interest-rate index plus a fixed lender margin. Payments can change after the fixed period according to that index, the contract margin, and the loan’s adjustment rules.
Key terms (short definitions)
– ARM (adjustable-rate mortgage): a mortgage whose interest rate can change after an initial fixed period.
– Index: a published market rate (for example, SOFR or the federal funds rate) used to reset an ARM’s rate.
– Margin: a fixed number of percentage points the lender adds to the index to determine your rate (rate = index + margin).
– Teaser rate: the usually-lower initial fixed rate during the introductory period.
– Rate caps: limits in the loan contract on how much the rate can increase per adjustment and over the life of the loan.
– Prepayment penalty: a fee some loans charge if you pay off or refinance the loan during an initial period.
How a 2/28 ARM works (step-by-step)
1. Borrow a 30-year loan with a two-year introductory fixed rate (the “2”).
2. During years 1–2 you pay the fixed monthly payment based on that initial rate.
3. At the two-year anniversary the loan re-prices. The new interest rate = chosen index + margin, subject to periodic and lifetime caps.
4. After the initial adjustment, the loan typically re-prices every six months (semiannually) for the remaining 28 years.
5. Monthly payments rise or fall with each adjustment. You may refinance or prepay, but early payoff may trigger a prepayment penalty if the loan includes one.
When buyers historically used 2/28 ARMs
– These loans were popular when buyers wanted very low initial payments (the teaser rate) and intended to refinance or sell before the rate started to float. That strategy failed for many borrowers when housing values dropped and refinancing became difficult.
Checklist: what to check before taking a 2/28 ARM
– How long do you plan to stay in the home? (Short expected tenure strengthens the case for a 2/28.)
– Initial rate and how it compares to a fixed-rate alternative.
– Index used (e.g., SOFR) and the lender’s margin.
– Adjustment frequency after year two (usually semiannual for 2/28 ARMs).
– Periodic cap and lifetime cap (how much the rate can increase at each adjustment and overall).
– Any rate floors (minimum possible rate) or payment floors.
– Prepayment penalty details and duration.
– Required documentation and whether the lender assessed your ability to carry higher payments.
– Stress-test your cash flow at higher hypothetical rates (e.g., +2–5 percentage points).
– Exit plan: refinance, sell, or accept higher payments?
Worked numeric example (rounded, assumptions stated)
Assumptions
– Home price: $350,000
– Down payment: $50,000
– Loan amount: $300,000
– Initial fixed annual rate: 5.00%
– Taxes & insurance escrow: $230 + $66 = $296/month (held constant in example)
– Adjustment after 2 years to 5.30%
– No prepayment or refinancing; ignore closing-cost differences
Step A — Initial monthly payment (years 1–2)
– Monthly interest rate = 5.00% / 12 = 0.004166667
– Standard mortgage payment formula gives principal-and-interest (P&I) ≈ $1,610 per month.
– Total monthly housing cost = P&I + escrow = $1,610 + $296 = $1,906.
Step B — After two years (rate rises to 5.30%)
– After 24 payments the outstanding loan balance is about $290,900 (amortization result).
– New monthly interest rate = 5.30% / 12 = 0.004416667
– Recompute payment for remaining term (28 years or 336 months) using the remaining balance:
– New P&I ≈ $1,664 per month.
– New total monthly cost ≈ $1,664 + $296 = $1,960 (rounded in the source to $1,961).
Notes on this example
– Numbers are rounded; escrow, taxes, insurance and the exact remaining balance will vary in practice.
– The example demonstrates how a small rate increase (0.3 percentage point) can raise monthly payments materially because payments are spread over the remaining 28 years rather than the original 30.
Pros and cons — practical view
Pros
– Lower initial monthly payments than a same-term fixed-rate mortgage.
– Useful if you plan to sell or refinance within the fixed period.
– Can free up cash for short-term needs (repairs, investments, etc.).
Cons / risks
– Payment shock: payments can increase after the initial fixed period.
– Refinancing risk: if house prices fall or credit tightens, you may not be able to refinance to a fixed rate.
– Prepayment penalties are common on these products during the fixed introductory period.
– Lifetime interest paid is uncertain and can be much higher if rates rise substantially.
How 2/28 ARMs compare with fixed-rate mortgages
– Predictability: fixed-rate loans lock a rate and payment for the entire term; ARMs do not.
– Initial cost: ARMs commonly offer lower introductory rates than fixed mortgages.
– Long-run cost: fixed-rate loans remove the risk of higher future interest; an ARM’s total interest depends on future market rates.
Practical tips before signing
– Read the ARM rider and note index, margin, caps, and prepayment terms.
– Run “what-if” scenarios: assume index moves up 2–5 percentage points and see if you can still afford the payment.
– Consider alternatives (e.g., 30-year fixed or a 5/1 ARM) and compare total costs and risks.
– Ask the lender how and when they notify you of upcoming rate changes.
– Get clear answers about any prepayment penalties and how long they apply.
Relevance of underwriting today
– Lenders now often require proof you can make payments if the rate rises; they rely more on ability-to-pay tests than during earlier boom cycles. Still, confirm how aggressively the lender underwrote the loan.
Sources for further reading
– Investopedia — “2/28 ARM”: https://www.investopedia.com/terms/2/228arm.asp
– Consumer Financial Protection Bureau (CFPB) — “What is an adjustable-rate mortgage (ARM)?”: https://www.consumerfinance.gov/ask-cfpb/what-is-an-adjustable-rate-mortgage-arm-en-131/
– Freddie Mac — “Adjustable-rate mortgages”: https://www.freddiemac.com/learn/adjustable-rate-mortgages
– Federal Reserve — Mortgages and housing resources: https://www.federalreserve.gov/consumerscommunities/mortgages.htm
Educational disclaimer
This explainer is for educational purposes only and is not individualized investment or lending advice. Mortgage features and rates vary by lender and jurisdiction. Consult a qualified mortgage professional or financial adviser for guidance tailored to your situation.