The average rates for a 5/1 ARM have dropped to 6.2%, which is significantly better than in 2023. Adjustable-rates mortgages are impactful as they allow you flexibility on payment.
Imagine: You can easily manage your finances according to the terms. Plus, you can even refinance the loan after the fixed rate period is over.
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What Is a 5/1 ARM?
5/1 is an adjustable-rate mortgage that changes after a specific time. Mortgage rates remain the same for 5 years and adjust annually until the loan amount is fully paid.
Unlike Fixed-rate mortgages, a 5/1 ARM has a changeable feature. Initially, the mortgages are low compared to 15 or 30-year fixed mortgages. However, you should be prepared for the increased interest.
How Does a 5/1 ARM Work?
Once you take a 5/1 ARM, there will be an initial rate period of 5 years. Meanwhile, you’ll pay a fixed interest rate on the loan amount. It’s similar to fixed mortgage rates.
As the initial period comes to an end, adjustments will start annually. That leads to potentially higher monthly payments. Therefore, to protect you from sudden rate increases, there are rate caps.
The rate cap sets a limit on how high your interest can rise, on a 5/1, Generally set at 5%.
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✍️ Note: Adjustments are based on the margin set by the lender, and are added to the index rate.
What Should I Look for When Shopping for a 5/1 ARM?
Consider these factors before shopping for a 5/1 ARM:
- Life of the Loan: Similar to a fixed mortgage loan, even an ARM has a set tenure to repay. Ensure it aligns with your budget.
- Risks: With adjustments, your interest rate will increase. Analyze the potential risk and rate caps.
- Lender Requirements: Compare lender fees, closing costs, and underwriting requirements. Look for lenders nearby to find suitable deals.
What Index Does the 5/1 ARM Use?
Generally, a 5/1 ARM uses these indexes:
- Prime Rate: This rate is available to creditworthy customers of commercial banks. However, it is only used for some indexes.
- Constant Maturity Treasury: This index is provided by U.S treasury securities that come with maturities.
- Secured Overnight Financing Rate: SOVR reflects bank rates that reserve banks charge each other overnight.
Pros and Cons of a 5/1 ARM
Here’s a breakdown of the advantages and disadvantages of 5/1 ARM:
Pros
- Savings: In the initial days your monthly payments are low. It will help you to save money for the future.
- ARM Caps: With cap rates, you can predict the future rates of your ARM.
- Switch/Refinance: Once your credit score rises and you become financially fit you can switch or refinance the mortgage.
- Pay off Mortgage Faster: Your extra monthly savings will enable you to pay off your mortgage faster.
Cons
- Unaffordable Payments: A sudden increase in interest can make your monthly payments unaffordable.
- Uncertain: Interest rates are uncertain. Your credit score will suffer if you are not able to pay.
- Availability: Lenders might not always agree to your terms. Therefore, availability is less.
Difference Between a 5/1 ARM and a 7/1 ARM
| Factors | 5/1 ARM | 7/1 ARM |
| Initial Period: | 5 years is the initial period. | 7 years is the initial period. |
Adjustment Periods: | Adjustments are made after the initial period (5 years). | Adjustments are made after the initial period (7 years). |
| Interest Rate: | The interest rate is low as the initial period is less. | The interest rate is high as the initial period is more. |
Bottom Line
5/1 ARM holds a lot of advantages. The lower interest and initial period make it suitable for you. However, it is important to understand your requirements. If you plan to opt for a 5/1 ARM. Consider the potential interest increase in the future. So, budget accordingly.
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Frequently Asked Questions
Can you pay off a 5/1 ARM early?
Yes, It is possible to pay off a 5/1 ARM early. either by refinance or switching. Once your credit score rises and you become financially fit you can switch or refinance the mortgage.
How does a 5/1 ARM works?
A 5/1 ARM is an adjustable-rate mortgage with a fixed interest rate for the first five years. After this initial period, the interest rate adjusts annually.
How long does a 5/1 ARM last?
A 5/1 ARM typically lasts for a total of 30 years. The first five years have a fixed interest rate. After that, the interest rate adjusts annually for the remaining 25 years.
