A 5/1 adjustable-rate mortgage (ARM) is a hybrid mortgage product that combines features of a fixed-rate and adjustable-rate mortgage. For the first five years, your interest rate will be fixed. And after that, your interest rate will adjust every year depending on the market.
A 5/1 ARM can be a great option for saving on interest upfront if you plan to either move or refinance your mortgage within five years. But it comes with the risk of a variable interest rate if you stick with the loan after five years, which could make your mortgage payment fluctuate substantially depending on how interest rates change.
How does a 5/1 ARM work?
A 5/1 ARM (5-year adjustable rate mortgage) works by charging a "fixed" interest rate for the first five years of the loan (60 payments) and then adjusting the interest rate annually for the next 25 years of the loan based on the market index.
The initial rate, known as a teaser rate, is typically lower than for a 30-year fixed-rate mortgage. This makes 5/1 ARM loans more appealing when interest rates are high. It also means your mortgage payment will stay the same for the first five years and fluctuate annually for the remaining 25 years.
Recently, 5/1 ARM loans are becoming more popular due to stubbornly high interest rates. Although ARM loans developed a bit of a bad reputation for getting people into financial trouble in the past, they can work as an important tool for making buying a house more affordable if utilized the right way.
5/1 ARM loan vs. fixed-rate mortgage
- A 5/1 mortgage will have a fixed interest rate for only five years, then the rate will adjust annually for the remaining 25 years of the loan. That means your monthly payments will fluctuate every year for 25 years.
- With a fixed-rate mortgage, your interest rate will stay the same for all 30 years — so will your monthly payments.
Fixed mortgage payments are generally more predictable than payments on ARMs — though rates for property taxes, insurance, or special assessments could affect your overall monthly payment.
However, the teaser rate on a 5/1 ARM will typically come in substantially lower than the rate for a 30-year fixed-rate mortgage. If you need a lower payment than the 30-year fixed rate is offering, then a 5/1 ARM might be a better option.
» SEE: More types of 5/1 mortgages
What's the 5/1 ARM loan rate?
To get a general range of what the current 5/1 ARM rate is, you can compare 5/1 ARM rate estimates on mortgage comparison shopping sites. But your lender will set the actual rate, based on the sum of the margin and an index rate as well as your personal financial factors. The rate will be reflected in your loan contract.
Your loan contract details terms such as the following:
- Length of your initial term
- Teaser interest rate
- Loan reset date
- How often your interest rate adjusts
- What factors and limitations can affect your interest rate (such as an index or interest rate cap)
Can you pay off a 5/1 ARM early?
Yes, you can pay a 5-year adjustable-rate mortgage (5/1 ARM) off early. But here's what you need to know before you make any decisions about paying one off early:
- Watch for prepayment penalties: Some lenders charge a penalty if you pay off or refinance your mortgage within the first few years. These fees typically apply during the initial five-year fixed period.
- Make extra principal payments: Paying more toward the principal reduces your balance faster and cuts down on total interest paid. This won't change the length of your fixed period, but it can shrink your loan balance, which can help if you plan to refinance the loan.
- Refinance into a fixed-rate loan: Refinancing before your ARM resets is a common strategy to pay off your ARM loan. If rates are favorable, you can lock in predictable payments and avoid potential hikes once your loan adjusts.
- Sell your home: Selling your property effectively pays off the mortgage, as long as you sell for a higher price than your remaining mortgage balance. This option makes sense if you plan to move within five years of buying the house.
💡 Tip: On a fixed-rate mortgage, extra payments shorten your loan term. On an ARM, extra payments mainly save interest, but don’t reset or shorten the fixed five-year period.
Different types of 5/1 ARMs
A jumbo loan is a home loan that exceeds the typical lending limits of Freddie Mac, Fannie Mae, the FHA, or the VA. Recently, ARM jumbo loans have had lower interest rates than their 30-year fixed-rate counterparts.
With an interest-only 5/1 ARM, you'll pay just interest for five years, then have an annually adjustable rate for the remainder of the loan. Lenders that offer interest-only mortgages typically require a higher credit score and a larger down payment, as much as 20%.
On an interest-only loan, you’ll pay only the interest portion of the mortgage (NOT the principal) for an initial period. After the initial term, the loan converts to a traditional (principal PLUS interest) mortgage, but the interest rate is subject to change every year.
The Federal Housing Administration offers two 5/1 ARM options through approved lenders:
- 1% increase annually, and 5% over the life of the mortgage
- 2% increase annually, and 6% over the life of the mortgage
If you have good to excellent credit, you’ll have higher approval odds for an FHA 5/1 ARM. This loan option offers a lower down payment requirement (3.5%) and a lower initial interest rate
When is a 5/1 ARM a good idea?
A 5/1 ARM is best for home buyers who want a lower initial monthly payment and expect their homeownership situation to change within five years, whether that's because they're moving, expecting their income to go up, or they're planning to refinance into a different type of loan.
đźš— Moving within 5 years
If you'll live in your home for only five years, then the money spent on principal, interest, taxes, and insurance on a loan with a higher interest rate might not be worth it for you. An ARM can help preserve cash for your next move and down payment. The risk is if something in your plans change and you can't move within 5 years. Then you would either be stuck with the adjustable rate or you'd need to refinance, which could potentially leave you with an even higher rate than what was available 5 years ago.
đź’° Expecting cash influx
When your 5/1 ARM interest rate increases, so will your monthly mortgage payments. If your finances are well equipped to handle a higher payment, then this could possibly not be a concern for you.
- With an income increase (e.g., because of a new job or raise), you might be able to cover a higher mortgage payment once your ARM resets if you don't want to move or refinance.
- With a windfall (e.g., inheritance or settlement), you could potentially pay your mortgage off before the rate resets.
đź’¸ Planning to refinance
Like moving, refinancing gives you an out of the loan before the higher rate sets in. After five years, you can choose a more predictable mortgage product that suits your needs. That said, there's no saying where rates will be 5 years from now and refinancing comes with additional costs that you'll want to take into account.
5/1 ARM disadvantages
The teaser interest rates offered by a 5/1 ARM sound like a great deal — and they can be when you're just starting your loan payments. The downside is that your interest rate will be unpredictable after five years, and it could put you in a tough spot financially.
A short-term ARM might not be right for you if you expect:
- The Federal Reserve to raise interest rates because of an economic downturn
- Your household income will not increase
- Your household expenses will increase
FAQ about 5/1 ARM loans
Yes, you can refinance a 5/1 ARM loan as long as you’re a credit-worthy loan applicant and the subject property meets the bank’s standards. You will also have to meet eligibility requirements like having a stable income, a certain debt-to-income (DTI), and other qualifications.
The 5/1 ARM floating interest rates are based on the margin (outlined in your loan agreement) and a market index, which changes daily. Your loan will have a cap that limits how high your interest rate can go for a given period and for the life of the loan.
Disclaimer: The information provided in this article is for informational purposes only. It is not intended as legal, financial, investment, or tax advice, and should not be relied upon as such. Consult a licensed financial advisor or tax professional regarding your personal financial situation before making any decisions.