2-2-8 Adjustable-Rate Mortgage (2/28 ARM): Meaning, How It Works

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2/28 Adjustable-Rate Mortgage (2/28 ARM): Meaning and How It Works

A 2/28 adjustable-rate mortgage (2/28 ARM) is a 30-year home loan with a fixed interest rate for the first two years and a variable rate for the remaining 28 years. The initial “teaser” rate is usually lower than comparable fixed-rate mortgages, after which the rate resets periodically based on an index plus a lender margin.

Key points

  • Introductory fixed period: 2 years.
  • Adjustment period: rate typically adjusts every six months for the remaining 28 years.
  • Rate formula after the fixed period: index (e.g., SOFR, Treasury rates) + margin.
  • Protections: many ARMs include periodic and lifetime caps that limit how much the rate can rise.
  • Common trade-offs: lower early payments versus interest-rate and payment uncertainty later; early prepayment penalties are common.

How a 2/28 ARM works

  1. Initial rate: Lender sets a fixed “teaser” interest rate for two years.
  2. Transition: After two years the loan converts to an adjustable rate. The new rate equals the current value of the selected index plus a fixed margin.
  3. Adjustment frequency: Most 2/28 ARMs adjust every six months after the introductory period.
  4. Caps and limits: Many ARMs include caps on how much the rate can increase at each adjustment and over the life of the loan; check the specific loan terms.

Example

Suppose you borrow $300,000 with a 2/28 ARM at a 5% initial rate. Your principal-and-interest payment would be about $1,610 per month; with $230 in monthly property tax and $66 in insurance, total housing costs would be about $1,906. After two years, if the rate rises to 5.3%, your payments would increase accordingly. Because future index values are uncertain, total long-term costs are unpredictable.

Risks and historical context

  • Interest-rate risk: After the fixed period, payments can rise substantially if benchmark rates climb.
  • Prepayment penalties: Because lenders earn little from the low initial rate, many 2/28 ARMs carry prepayment penalties during the early years.
  • Refinancing risk: The original strategy for many borrowers was to refinance after two years. If home values fall or credit tightens, refinancing may be unavailable.
  • Market lessons: During the 2000s housing boom, many borrowers underestimated how small rate increases could sharply raise monthly payments. The 2008 market collapse showed the downside when refinancing or selling isn’t possible.

Lenders now more closely evaluate a borrower’s ability to handle rising adjustable payments.

2/28 ARM vs. fixed-rate mortgage

  • 2/28 ARM: Lower payments early, higher uncertainty later. Good for borrowers who expect to sell or refinance before rates adjust or who can tolerate payment volatility.
  • Fixed-rate mortgage: Predictable payments for the loan term, which simplifies budgeting and protects against rising rates. Often preferred for long-term stability.

Who might choose a 2/28 ARM

You might consider a 2/28 ARM if:
* You need lower payments immediately and plan to move, sell, or refinance within a short timeframe.
* You expect your income to increase and can absorb potential payment rises.
* You accept the risk of payment variability in exchange for lower initial costs.

Avoid a 2/28 ARM if:
* You need payment stability or have limited ability to absorb increases.
* You cannot tolerate the possibility of prepayment penalties or a refinancing failure.

Other related notes

  • Alternative ARMs: Common hybrids include 5/1 ARMs (fixed 5 years, then adjusts annually) and 3/27 ARMs (fixed 3 years, then adjustable for 27 years).
  • Paying off an ARM early: Check your loan documents—some ARMs impose prepayment penalties during early years.
  • Refinancing: Possible, but depends on home equity, credit, and prevailing rates at the time of refinancing.

Bottom line

A 2/28 ARM can offer lower initial payments than a 30-year fixed mortgage, making it useful for certain short-term plans. However, it transfers significant interest-rate and payment risk to the borrower after two years. Carefully review the index, margin, adjustment frequency, caps, and any prepayment penalties before choosing this loan.