Ever wondered about the difference between a 5/1 ARM and a 5/5 ARM, or a 7/1 ARM and a 7/6 ARM? Let’s break it down. An adjustable-rate mortgage (ARM) is a type of home loan that starts with a fixed interest rate, then adjusts after a certain period. The first number in the ARM name tells you how long the fixed rate lasts. So, in a 5/1 ARM, you get a fixed rate for five years. The second number tells you how often the rate adjusts after that. So, in a 5/1 ARM, the rate adjusts every year after the first five years.
Now, the main difference between a 5/1 and a 5/5 ARM is that the 5/1 ARM adjusts every year after the first five years, while a 5/5 ARM adjusts every five years. ARMs with a fixed-rate period of more than one year are pretty rare, but they do exist.
ARMs usually have lower rates than 30-year fixed-rate mortgages because they’re shorter. So, as mortgage rates rise, more people might choose ARMs. For example, a 3/1 ARM has a fixed rate for three years, a 5/1 ARM for five years, and so on. There are even 10/1 ARMs, but they’re not as common because they’re similar to 15-year fixed-rate mortgages, which often have competitive rates.
There are also 7/6 ARMs and 10/6 ARMs. Here, the 6 means six months, not six years. So, after the initial fixed-rate period, the rate adjusts every six months.
When choosing an ARM, it’s important to look at the yield curve, which shows the relationship between interest rates and the time to maturity of debt. When I took out my 7/1 ARM in early 2020, the yield curve showed that 7/1 ARMs offered the best combination of low rates and a long fixed-rate period. So, I went with a 7/1 ARM for two more years of rate stability.
The biggest difference between a 5/1 and a 5/5 ARM is that the 5/1 loan adjusts more often. So, if the rates and costs are the same, a 5/5 ARM might be a better choice. But remember, there’s no such thing as a free lunch. Even no-cost refinances have costs, usually in the form of a higher rate.
A 5/5 ARM usually has a slightly higher rate than a 5/1 ARM. So, you’ll need to decide how much you value the peace of mind of four more years of a fixed rate, how much the rate can jump during each adjustment period, the lifetime cap on the rate, where you think rates will be after the fixed-rate period, and the margin and index used to calculate the adjustable rate.
One reader shared that they chose a 5/5 ARM over a 5/1 ARM. They liked the lower margin (the bank’s profit) and the fact that rates are currently rising more on the short end. They also liked knowing that the maximum rate for years 6-10 would be 3.875%. Even if the rate adjusts by the maximum 2%, the average rate over 10 years is only 2.875%.
It’s easy to see why most people choose 30-year fixed-rate mortgages. They’re simpler and easier to understand. But if you’re willing to learn about ARMs, you could save a lot of money.
In a rising rate environment, a 5/5 ARM might be more attractive because the rate adjusts less often. In a falling rate environment, a 5/1 ARM might be more attractive because the rate can adjust down more quickly. But predicting future rates is hard, so it’s usually best to go for the lowest rate with the lowest fees.
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