5/1 ARM - the rate is fixed for a period of 5 years after which in the 6th year the loan becomes an adjustable rate mortgage (ARM). The adjustable rate is either tied to the 1-year treasury index or to the one-year London Interbank Offered Rate (“LIBOR”), and is added to a pre-determined margin (usually between 2.25-3.0%) to arrive at your new monthly rate. Ask what the margin, life cap and periodic caps of your ARM will be in the 6th year. The loan is fully amortized (or paid off) in 30 years if the normal payment schedule is followed. (Also see anatomy of an ARM for additional information).
When considering a home purchase, you have a wider variety of mortgage choices than ever before. One of the most asked after, and potentially misunderstood, mortgages is the Adjustable Rate Mortgage (ARM). The ARM is a mortgage option where the interest rate can increase or decrease. In contrast to typical fixed-rate mortgages, the monthly payments may vary according to agreements and lenders.
ARMS are touted as a deal for borrowers, as the average ARM rate is usually less than the average interest rate for fixed-rate mortgages. This translates to lower monthly payments. What’s not to love?
These mortgages can in fact be great deals, especially the 5/1 Adjustable Rate Mortgage, in which the ARM rate stays steady for five years. But borrowers should do some careful research and be aware of risks prior to enlisting.
First, let’s look at how ARM rates are calculated. For many typical ARMs, the lender uses a low and attractive rate in the first year to entice borrowers. For mortgages that are adjusted each year, known as 1/1 mortgages, the rate becomes tied to a publicly known index such as Treasury bills. On top of this index, the lender adds a “margin,” typically about 2.75 percent, to create a new and higher interest rate.
Under this model, an ARM that starts at 5.75 percent can increase to 7.75 percent in the second year, to 9.75 percent in the third year, and 11.75 in the fourth year. This means monthly payments will nearly double.
ARMs under the 5/1 model are much more secure. Adjustments only begin after five years. However, at that point, adjustments will commence each year, capped by the maximum two percent increase (some 5/1 ARM's are capped by the maximum of five percent on the first adjustment - be sure to ask your loan officer about this and read your Promissory Note carefully).
Current 5/1 ARM Rate Quotes
If you are looking to stay in your house for the long term, even 5/1 adjustable rate mortgages may not be appropriate. The yearly increase in rates after the initial five-year period can bring some risk into your finances that fixed-rate mortgages would not.
How do you compare adjustable rate mortgages? It’s more complex than simply comparing fixed interest rates, monthly payments, fees, and more. Instead, comparing ARMs, you need a lot more information. Consider the terms and considerations below: