How does a 5/1 ARM mortgage work?
A 5/1 ARM differs from a fixed-rate mortgage because the interest rate is only fixed for a limited time. For the first five years, you pay the rate you started with when you borrowed. After that, rates can change once annually.
When your interest rate adjusts, the new rate on a 5/1 ARM is determined by a financial index. This is called the benchmark index. The index used to adjust your rate will be disclosed to you up front. Often, the benchmark index is the Fed Funds Rate or the LIBOR index.
Adjustable-rate mortgages like a 5/1 ARM are usually repaid over 30 years. The time it takes to pay off your loan will never change. But the interest rate and payment due can change as the benchmark index does. If the rate rises, your monthly payment goes up. That’s because more money is needed to cover interest costs while paying down principal. Paying both ensures your loan is paid off on time.
When you take out a 5/1 ARM, your initial mortgage documents will indicate the maximum amount the rate can go up. Make sure your payment would still be affordable even if it went up by that amount.
How to compare 5/1 ARM mortgage rates
Most mortgage lenders offer adjustable-rate mortgages. Some of these include banks, online lenders, and credit unions. You should get quotes from multiple lenders. Look for the most affordable interest rate and the best overall loan terms.
Be sure to compare 5/1 ARMs only to other adjustable-rate mortgages with the same initial fixed-rate period. A 15-year or 30-year fixed-rate mortgage will likely have a higher interest rate. Remember that while you pay a lower starting rate with a 5/1 ARM, your payment could rise sooner than with a 7/1 ARM. And no adjustable-rate mortgage offers the predictability of a fixed-rate loan with a payment that never changes.
When comparing lenders, find out the terms that would apply if you borrow. Look for providers who do not require a hard credit check to get pre-qualified. Too many hard inquiries can reduce your credit score.
Be sure to compare more than just interest rates. Also look at total fees each lender charges, as well as qualifying requirements and possible penalties. The Annual Percentage Rate (APR) includes the cost of both fees and interest, so comparing APRs can be more accurate than comparing interest rates alone.
