What is a 5/1 ARM?

A 5/1 Adjustable Rate Mortgage (ARM) is a mortgage in which the rate is fixed for 5 years and in the sixth year, the loan becomes an ARM. The new rate is determined by an economic index (usually treasury or treasury average index) or by 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. The loan is fully amortized (or paid off) in 30 years if the normal payment schedule is followed.

Who should get a 5/1 adjustable rate mortgage?

A 5/1 ARM is popular in a hot real estate market where houses appreciate quickly, or with people who aren’t expecting to stay in a home for long, or for those expecting to refinance before the rate adjusts.

What are the advantages and disadvantages of a 5/1 ARM?

The pros of a 5/1 ARM: the initial rates are lower than fixed-rate mortgages; you can qualify for a higher loan amount with an ARM (due to the lower initial interest rate), and if the interest rate drops, your monthly payments will also drop.

The cons of a 5/1 ARM: The rates will increase after the adjustment period on an ARM and they can be quite high. Also, planning that a refinance will bail you out is risky because rates could be extremely high down the road.