5/1 ARM Mortgage Rates

    5/1 ARM Mortgage Rates: How To Get The Best Rates

    When you shop for mortgages, you're generally offered two major mortgage types: fixed-rate and adjustable-rate mortgages. An adjustable-rate mortgage (ARM) features an interest rate that fluctuates, which could possibly grant you lower rates depending on the market. However, you should still pay attention to how an ARM works, so you don't get stuck with a prohibitively high-interest rate.

    In this guide, we'll discuss adjustable-rate mortgages in detail. We'll define what ARMs are, why it's a good choice, and why an ARM might be the right choice to finance your home. We also provide tools to help you get a personalized rate estimate of your adjustable mortgage.

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    What Is An Adjustable-Rate Mortgage? 

    An adjustable-rate mortgage is a type of home loan that has a fluctuating interest rate and annual percentage rate (APR), meaning that it may raise or lower over the life of the loan. Most ARMs have a set period of years at the start of their loan term where it features a fixed interest rate. This is an introductory period before the rates adjust. The period when the interest rate adjusts may vary, but most loans adjust their rates annually.

    The length of an ARM's introductory and adjustment periods are usually expressed in the name of the loan. If you have a 5/1 ARM, it means that you'll go through the initial fixed-rate period for the first five years, after which the mortgage rate adjusts every year. 

    Most ARMs adjust their interest according to a market-driven index rate. To control your interest rate fluctuations, lenders also implement two kinds of caps. The period adjustment cap controls your rate's fluctuation during an adjustment period, while lifetime caps are required by law to limit rate increases throughout the loan's lifetime. 

    Advantages Of A 5/1 ARM 

    While ARM mortgages are generally not as popular compared to the more common 30-year fixed-rate loans, they offer several advantages, which we'll break down in this section.

    Low Initial Payments

    Most people are drawn to 5/1 ARM loans because of the lower interest rate during the first five years of the loan. An ARM's introductory interest is also usually lower than other mortgage types. By taking advantage of the introductory period, you can enjoy predictable and low-value monthly installments. 

    Due to this period of low initial monthly payment amounts, you can also potentially qualify for a larger loan and afford a more expensive house. Lower mortgage interest rates also mean you'll be able to pay off more of the loan's principal each month, building equity faster. As an added benefit, you can provide as little as a 5% down payment.

    More Flexibility

    A 5/1 ARM mortgage is a good option if you don't see yourself staying in the same house for a long time. You can leverage your adjustable mortgage by selling the house within the five-year fixed-rate mortgage period, avoiding the fluctuant adjustable phase before it starts. 

    Interest Rate Changes Are Capped

    While 5/1 ARM rates may fluctuate, mortgage lenders are required to place a rate cap on your interest. By examining the period adjustment and lifetime caps on your loan, you can estimate whether you can afford this mortgage even in the worst-case scenario of a dramatic interest increase.

    Another added benefit is that, in periods of low interest, you may still see low monthly payment amounts during the adjustable period.

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    Disadvantages Of A 5/1 ARM 

    While a 5/1 ARM offers benefits that a fixed doesn't, there are some caveats that you should keep in mind.

    Interest Rates May Rise 

    Because the interest rate can change, you may enjoy cheap loan payments one year and then see your ARM rate jump the next – forcing you to pay an expensive monthly mortgage payment. If you're not prepared to handle these mortgage rate changes, you may find yourself in a financial bind.

    If you have an unstable income, a 5/1 ARM may be riskier because you risk not being able to pay when interest rates rise. Your current income may not be enough to handle the payments without stretching your finances too thin. The fluctuating rates may also cause you to build your home equity slower during periods of high interest.

    Some Loans Have Prepayment Penalties

    While a 5/1 ARM loan is popular with people who want to sell their home or get a refinance once the low-interest introductory period is over, some lenders may impose prepayment penalties. You'll be charged with this penalty if you sell your house or refinance within the introductory period, causing you to lose money.

    If you're planning to sell your house or refinance the mortgage, we recommend that you find a lender who doesn't apply this penalty to their ARMs.

    Risk Of Negative Amortization

    While caps help regulate your monthly installments, there are times when they may actually work against you. If your ARM rate rises high enough and hits the payment cap, you may end up not paying all the interest you owe that month. Because you still have leftover interest from that month, it'll be charged the next month, and your loan amount will actually increase.

    Is An ARM Right For Me? 

    Due to its unpredictability and the risk of being saddled with expensive monthly payments, ARMs aren't for everyone. Usually, ARMs are right if you don't plan on staying in the same house for long. If you're looking to sell the property before the five-year fixed-rate period elapses, you might be able to save money.

    If you're confident about getting a high-paying job – for example, you're a recent medical or law school graduate and expect to land a lucrative position – a 5/1 ARM may benefit you. Thanks to your high pay, you can save money while being confident that you can handle any mortgage rate increases. 

    A 5/1 ARM loan may also be advantageous if you're planning to pay it before the term ends. While it's not a viable strategy for most people, you can save money by paying off the entire loan balance during the period of low interest before the annual reset happens. 

    However, you don't necessarily need a 5/1 ARM just because the mortgage rate is especially low. If you can get comparable rates on a 30-year fixed-rate mortgage, you can eliminate the unpredictability of fluctuating interest rates. 

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    Applying For An Adjustable-Rate Mortgage Refinance 

    Refinancing is one of the most popular methods to save money on your loan. You refinance by taking out a loan with more affordable mortgage rates to pay off your current one, resulting in savings in the long run. If you have an ARM, you have three options when your rates are about to undergo their annual reset.

    The first alternative is to let the loan adjust. This means that things will go as normal and your interest rate will go up or down according to the index used. Typically, a 5/1 ARM uses the London Interbank Offered Rate (LIBOR) as their index of reference.

    The second option is to refinance into a new 5/1 adjustable-rate mortgage. If you’re looking to move out of your current home in the next few years, you’ll be able to enjoy a longer introductory period while you attempt to sell your house.

    The final alternative is to refinance into a fixed loan. Typically, you use this to protect yourself from changing mortgage rates. If you expect the economy to improve in the near future and plan to stay in your current home for longer, you can refinance at a fixed rate.

    Conversely, you can also refinance your fixed-rate mortgage into a 5/1 adjustable-rate mortgage. You may decide to do this because you’re looking to sell your home and wish to get a lower rate for the first 5 years.

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    Alternatives To Adjustable-Rate Mortgages 

    Due to their unpredictability, ARMs may not be for everyone. Here are three other home loan options that you can consider to finance your property purchase.

    Fixed-Rate Mortgages

    One of the most common types of home loans, a fixed-rate mortgage charges you a certain interest rate and APR for your whole life. You’ll be paying the same amount of money for each monthly installment. These loans also require a minimum 5% down payment, similar to an ARM.

    30-year fixed-rate mortgages are popular because they’re predictable and much easier to budget, thanks to their lower monthly installments. You’ll also be protected from any fluctuations in the market that may impact your mortgage rates.

    However, timing is important when applying for a fixed loan. If you apply at a time when mortgage rates are high, you’ll be stuck with that high-interest rate and APR for the rest of your loan.

    VA Loans

    If you’re a current or former service member, you can opt for a VA loan. Administered by the Department of Veterans Affairs, these loans are geared to help military personnel find new homes easier. These loans feature competitive interest rates and typically don't need a down payment.

    To balance out the lack of down payment, VA loans have stricter property appraisal requirements – for example, you can only use them to buy your primary home. You’ll also be required to pay a funding fee set by the government to cover foreclosing costs if you default on the loan.

    FHA Loans

    Federal Housing Administration (FHA) loans are designed for low-to-moderate-income homebuyers and feature a lower credit score and down payment requirement. If you opt for an FHA loan, you can expect to pay a minimum of 3.5% down. These loans have a credit score requirement of at least 580. 

    However, FHA loans require you to get mortgage insurance for the entire home loan term. These loans are also typically only able to afford properties with lower home value due to their conforming loan amount limits.

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    Closing Thoughts 

    5/1 adjustable-rate mortgages can be an option if you’re looking for the best mortgage rates early in the loan. They can also be great for people who don’t have the funds for a large down payment or are not planning to stay in their current home in the long term. However, you should pay attention to the prepayment penalties some lenders may enact on these loans if you’re looking to sell your house before the introductory period ends.

    If you’re looking for an adjustable-rate mortgage after getting an estimate using our tools, Wesley Mortgage, LLC is here to help! Our team of financial professionals can assist you in finding the best mortgage that suits your needs. Contact us today for more information!

    Written By Ed Wallace
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