What is a 5/1 ARM?

A 5/1 ARM is a type of hybrid mortgage where your interest is fixed for the first five years of the term and adjusts annually thereafter.

Pat Howard 1600

Pat Howard

Published April 9, 2019

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A 5/1 adjustable-rate mortgage (ARM) is a type of hybrid mortgage that has both a fixed- and variable-interest rate period. With a 5/1 ARM, the interest rate is fixed for the first five years of the mortgage, and then the rate will adjust annually (indicated by the 1 in 5/1) until the loan is paid off.

With a 5/1 ARM, you’ll find that your interest rate during the initial fixed-rate phase is lower than that of a standard 30-year fixed-rate mortgage. There’s also the possibility that interest rates could decrease once your fixed-rate period ends, lowering your monthly payments. The savings potential makes 5/1 ARMs and other kinds of hybrid loans attractive to potential borrowers.

However, 5/1 ARMs are also a risky mortgage option, as rates can fluctuate based on the economy and other factors outside of your control. Furthermore, if interest rates are predicted to go up toward the end of your fixed period and you’re not able to sell or refinance your home, you could end up with a mortgage you can no longer afford. If interest rates are already pretty low, a fixed-rate mortgage might be a smarter bet in the long run.

In this article:

5/1 ARM explained

A 5/1 ARM is defined by two periods:

  • The five-year fixed-rate period where your interest rate stays the same
  • The adjustment period, where the interest rate changes on an annual basis depending on the market index (the benchmark that lenders use to make rate adjustments)

However, your initial five-year fixed rate isn’t tied to the market index; you’ll typically get a “discounted” interest rate that you pay for with discount points as part of your closing costs. An initial rate that’s higher than the indexed rate is called a “premium” rate.

After 60 months of equal monthly payments, you’ll have your first interest rate adjustment, and your rate will adjust annually until the loan is paid off. To protect borrowers from ballooning interest rates, your agreement has certain safeguards, or caps, that limit how much your interest rate can change. There are two types of interest caps:

Periodic adjustment caps

These caps limit how much your interest rate can change per adjustment period. Periodic adjustment caps typically have two phases:

  • An initial adjustment cap, which says how much the interest rate can change during the first adjustment after the fixed-rate period ends
  • And a subsequent adjustment cap, which says how much the interest rate can increase in the years following the initial adjustment

Lifetime caps

Lifetime caps limit how much your interest-rate can increase over the life of the loan. Lifetime caps are typically required by law.

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5/1 ARM pros

The biggest argument for a 5/1 ARM over a traditional fixed-rate mortgage is the lower interest rate, expressed as an APR, during the initial fixed five-year period. That means that during the first 60 months of your mortgage, your monthly payment will be lower which could save you thousands over the life of your mortgage.

That makes 5/1 ARMs especially enticing for borrowers who don’t plan on staying in the home long, or who simply bought the home as an investment property to sell later on.

Since mortgage payments are structured so that interest is paid off sooner, the lower 5/1 ARM rate means more of your money can go toward paying off the mortgage balance, and that helps you build equity. The more home equity you have, the more likely you are to sell the home for a profit.

The table below is a five-year payment comparison of a fixed rate mortgage with a rate of 4.5% and an initial 5/1 ARM rate of 3.5%. The mortgaged property in the example has an initial balance of $250,000.

Mortgage (APR)Monthly PaymentTotal Paid After Five YearsBalance after five years
30-year fixed-rate (4.5%)$1,266.71$76,002.60$227,895.03
5/1 ARM (3.5%)$1,122.61$67,356.60$224,242.68

In this example, a 5/1 ARM would save you $144 a month and a total of $8,646 over the first five years of the loan. Additionally, you’ll have a few thousand dollars more in equity which will go directly into your pocket if you decide to sell.

There’s also the possibility that your interest rate could actually decrease after the initial fixed-rate period ends. If interest rates go down, then your monthly mortgage payment could too.

5/1 ARM cons

Although there’s a possibility that your interest rate will go down in year six, it’s highly unlikely, as ARMs typically adjust higher, not lower. If rates skyrocket and you’re unable to sell the home or refinance it, you could be stuck paying a mortgage you can no longer afford.

Rates are already low

It’s also difficult to justify going with an ARM if interest rates are low to begin with, or if the interest rate spread between an ARM and a traditional fixed mortgage is fairly low and you can afford the marginally higher mortgage payment.

Refinancing is expensive

Part of the appeal of 5/1 ARMs is the savings potential for borrowers who move around frequently. If you qualify, you also have the option to refinance into lower rates. This may be a viable option if you can refinance into a lower fixed-rate mortgage, but refinancing is also expensive, as you have to pay the same closing costs that you paid when you first bought the home.

You plan on owning the home long term

If you plan on staying in the home for a while, a fixed-rate mortgage would be a safer bet. Before deciding on a 5/1 ARM, make sure to look at how the rates compare to 15- or 30-year traditional mortgages. You can find up-to-date weekly average on the Freddie Mac website.

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