What is a 5/1 ARM Loan? | Ultimate 5/1 ARM Guide
What is a 5/1 ARM loan? When it comes to different financing types, you can score for buying or refinancing homes. Mortgage lenders can choose between a plethora of other options. On top of that, you may choose between a fixed-rate loan, an adjustable mortgage loan, or a variable-rate mortgage. However, keep in mind that nowadays, ‘adjustable’ and ‘variable’ are used interchangeably.
One type of adjustable-rate mortgage boasting a fixed initial rate is 5/1 ARM. During the initial loan period of the first five years, the interest is typically fixed at a rate lower than other fixed-rate mortgages, making them a popular option. Let’s delve into the details of 5/1 ARM loans.
5/1 ARM Mortgage Rates Explained
Adjustable rates typically change over time but always begin with an introductory rate that remains constant over five years. These may go up as much as 2 percent points per year depending on different factors. Let’s discuss what these rates are:
An adjustable-rate mortgage, also known as ARM, refers to a type of mortgage in which the interest rate applied on balance may vary across the loan life.
Typically in adjustable-rate mortgages, the initial interest is fixed for a specific period. After this time period, the interest rate may go up or down annually or monthly.
Adjustable-rate mortgages may also be referred to as floating mortgages or variable-rate mortgages. The interest rate for ARMs generally rests based on an index, benchmark, or ARM margin.
What is a 5/1 ARM?
A 5/1 adjustable-rate mortgage, otherwise known as 5/1 ARM, refers to an adjustable-rate mortgage. Typically, these boast a fixed interest rate lasting the initial five years that adjusts over the year.
The ‘5’ here expresses the number of years featuring a fixed rate, whereas the ‘1’ refers to how often the mortgage rate will adjust after the initial term.
In 5/1 ARM loans, the initial fixed interest rates boast a low introductory level. As the initial period ends, the adjustable interest rate will change yearly based on various financial and economic market factors.
It means that your interest rate will reset to the indexed rate after the introductory period if the index spikes up. In case it falls, so will your interest rate.
Is a 5/1 ARM Right for You?
ARMs are the ideal option to select when rates are skyrocketing. These first became available to homeowners across the U.S. in 1981 and have continued to grow in popularity ever since.
These are perfect for people planning to refinance their mortgage or sell their home before the introductory rate expires. A 5/1 ARM may also make sense if you think the value of your home will go up suddenly. Moreover, selecting an ARM provides you with the opportunity of qualifying for a larger loan.
The Pros and Cons of a 5/1 ARM
The pros of a 5/1 ARM start from the flexibility and go up to low introductory rates. At the same time, the cons include the potential for substantially bigger payments and complexity:
5/1 ARM Pros
Let’s discuss the top pros of 5/1 ARM loans:
Lower Initial Interest Rate
Since interest rates change in 5/1 ARM loans, these are structured to provide you with a lower interest rate for the initial years of the loan. The lower payment provides you with the financial flexibility necessary for buying things essential for your home.
Potential to Pay Less Overall Interest
One incredible way to save money during the 5/1 ARM loan term is to start putting the money you save from the lower interest rate towards the principal.
As a result, even if the interest goes up during the adjustment period, you’ll be paying less due to a low balance.
May be Better Short-Timers
5/1 ARM is perfect for those living in a starter home; especially if you plan to move out before the interest rate can adjust.
For this, you may have to plan early, but if all goes smoothly, you can enjoy avoiding increasing rates.
5/1 ARM Cons
These are as follows:
Higher Mortgage Payment Long-term Possibility
If interest rates start skyrocketing, there’s a chance you may have to deal with increased mortgage payments once the adjustable period begins.
It may be challenging for borrowers that have trouble making larger payments.
Refinancing to a Fixed Rate Will Lead to Fees
While you have the option of refinancing a fixed-rate mortgage, keep in mind that you’ll also have to pay a closing cost when refinancing.
The closing cost may be paid in the form of upfront fees or paid overtime by taking a higher interest rate. Moreover, the closing price may be between 3% and 6% of the loan amount.
Rate Difference May Not be Worth it
With falling interest rates comes the narrowing of the yield curve, which represents the difference between the fixed and adjustable-rate mortgages.
Therefore, if you’re saving a substantial amount through an ARM, your 5/1 ARM loan is worth it. However, if the difference is simply ten basis points, it may not be worth it.
To Sum it Up
You should consider getting a 5/1 ARM loan if you’re planning to refinance your mortgage or sell your house. If you select an ARM, you can easily qualify for a larger loan due to low introductory rates.
However, remember that interest rates and monthly payments will spike up after the introductory period, i.e., after three, five, seven, or ten years. Besides, they may increase by a considerable amount depending on the terms defined by your loan.
This page last updated: March 21, 2022
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