With so many mortgage programs available, it can be hard to determine which one is best for your specific needs. Although the 30 year fixed rate mortgage has traditionally been the most common for borrowers in the U.S., it may not necessarily be the best option for everyone. Consider the adjustable rate mortgage (ARM for short.) With an ARM loan, the interest rate is typically fixed for a set amount of time. In the case of a 5 year ARM (or 5/1 ARM), the interest rate is fixed for the first five years. It then is adjusted once a year, for the remainder of the loan.
Although many borrowers avoid ARM loans fearing they are too risky, an ARM loan can be a great financial opportunity for the right home buyer.
So why would you consider a 5 Year ARM?
1. You Can Get Low Rates
Banks and mortgage lenders generally offer lower initial interest rates on ARM loans for the fixed time period (in this case, the first five years). In fact, initial ARM rates tend to be significantly lower than rates associated with 30-year fixed rate mortgages (though this is not always the case - check current pricing to be sure.) But keep in mind, after the fixed rate period is up, the rate will start to fluctuate.
2. You Do Not Plan On Staying In The Mortgage More Than 5 Years
Since the interest rate will begin to adjust after the first five years, many people who choose a 5/1 ARM do so because they intend to sell their home or refinance within the fixed-rate time period. A 5/1 ARM can also be a great option if you expect your income to significantly increase within that time period, making a higher payment manageable in the later years of the loan.
3. You Could End Up Paying Less, Overall
Since banks will generally offer lower initial interest rates on 5/1 ARMs, you're already saving some money for the first five years of your loan. A lower interest rate means a lower monthly payment. Compare a 5/1 ARM scenario with that of a 30-year fixed rate mortgage, and you can see the savings. Say you take out a $200,000 30-year fixed rate loan at a rate of 5.35%. That would make your payments $1104/month. With a 5/1 ARM loan at an initial rate of 3.99%, you would be paying $953/month for the first five years. That would give you a five-year savings of more than $9,000!
4. ARM Rate Don't Always Increase
It is a popular misconception that after the fixed-rate period is over, the interest rate will automatically skyrocket. Depending on the current status of the market, interest rates can either go up or down. Your 5 year ARM could have a 4.5% interest rate in the beginning but when the time comes for the rate to adjust, market prices could be lower. This could allow more savings, more money to pay toward your principal balance or the chance to pay off debt. Of course, it's also possible that the rate could adjust higher and important to have a plan for handling a potentially higher payment.
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