You’ve probably heard of an ARM, an adjustable-rate mortgage.
But what exactly is a 5-1 ARM?
We will explain how an adjustable-rate mortgage works and how they compare to the more common 30-year fixed-rate mortgage.
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What is a 5-1 ARM?
A 5-1 hybrid ARM (5-1 hybrid adjustable rate mortgage) is a type of adjustable rate mortgage term with a very low initial rate for a fixed period. After the initial 5 year period the rate increases annually.
The first number is the fixed rate period, where 5 refers to the amount of years with a fixed rate. The second number is the rate at which the interest rate increases, 1 being every year. The 5-1 ARM is just one type of adjustable rate mortgage, there are many other terms available.
Why would anyone want an adjustable rate mortgage?
It’s quite simple really.. The initial fixed rate is usually much lower than you would receive with a fixed rate mortgage. With a 5-1 ARM the first 5 years of the mortgage will have a rate as much as 1% – 1.5% lower than a fixed rate.
This will result in a lower monthly payment and more of that payment going to your principle balance. After the initial 5 years that great low rate will increase year after year.
Over the first 5 years of a 5-1 ARM you will save a nice chunk of money. If you’re someone who is planning on paying off your mortgage within 5 years, then an adjustable rate mortgage is a no brainer. It will have the lowest interest rate, saving you the most amount of money. You don’t have to worry about the interest rate increasing after the five year period.
However, if you’re not planning on paying off your mortgage in 5 years you may want to think twice before getting an adjustable rate mortgage. Depending on what happens to interest rates over time, the interest rate hike could be much higher than you expected.
You could be able to refinance at the end of the initial 5 year fixed rate period. However, many borrowers prefer to lock in their rate over the full term of their loan with a 15 year or 30 year fixed rate mortgage.
5-1 ARM Advantages
- Low initial interest rate
- Lower monthly mortgage payments
- Pay more towards principle in the first 5 years
- Can qualify for a more expensive home
Other popular ARM terms
- 5/5 ARM
- 10/1 ARM
- 7/1 ARM
- 3/1 ARM
30 Year Fixed Rate Mortgage Loan
The 30 year fixed rate loan is the most common mortgage term there is. It’s the easiest to understand and it’s a safe bet for the typical homeowner who is not going to pay off their mortgage anytime soon. With a 30 year term you can lock in your interest rate for the life of the loan. While the prime rate goes through unpredictable highs and lows your mortgage rate stays the same.
Many people blamed adjustable rate mortgages for the 2008 housing market crash. While that wasn’t the only reason for the crash, it is partly true. The safety and security of a fixed rate mortgage ensures no changes in your payment and no surprises down the road.
30 Year Fixed Rate Advantages
- Locked in interest rate
- No interest rate hike
- Predictable monthly payment
- Take advantage of todays low interest rate
15 Yr Fixed-Rate Mortgage
A 15 year fixed rate mortgage works just like a 30 year fixed rate. You will have a locked in interest rate for the full 15 year term of the loan. 15 year fixed rate loans often have a much lower rate than a 30 year loan which makes them appealing. However, your monthly mortgage payment will be higher than it would with a 30 year term.
Which is Better 30 Year Fixed Rate or 5-1 ARM?
This will depend on your individual situation. Because a 5-1 ARM has a low initial interest rate for the first five years. If you plan on paying off your loan within 5 years then it is a great option for you.
If you are someone who is not paying off their mortgage in the next 5 or 10 years then the security of the locked in payment of a fixed rate mortgage may be the better option. As always you should speak to an experienced loan officer to go over all of your available options
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Randall has over 15 years of experience in the mortgage and credit industries. He spends a chunk of time helping consumers understand their credit, advise them on how to increase their credit, and lending his mortgage expertise to help them find the right type of loan. Randall lives in Dallas, Texas with his two sons.