Most homeowners move within 8 years
A 30-year fixed-rate mortgage is the most popular home loan. But because the typical homeowner moves every eight years, a 5-year adjustable-rate mortgage may be a good option for some first-time home buyers. If you choose a 5/1 ARM but move within five years, you could benefit from a lower rate without ever having to worry about your loan adjusting.
What is a 5-year adjustable-rate mortgage?
An adjustable-rate mortgage (ARM) is a home loan that offers a low interest rate for an introductory period, typically anywhere from three to 10 years. When that introductory period ends the rate can fluctuate, depending on market conditions — though in most cases, “fluctuate” means the rate goes up.
A 5/1 ARM, the most popular type, has a 30-year loan term in total. Your low intro rate is fixed for the first 5 years and can adjust once per year after that for the rest of the loan term. Similarly, a 7/1 ARM has a fixed rate for the first seven years and a 10/1 ARM for ten years.
Most ARMs have a cap on how high the rate can go.
ARMs are attractive to many buyers because initially, they offer lower mortgage rates than a fixed-rate loan. Depending on the introductory rate, the savings can be significant.
Let’s say you get a 30-year, fixed-rate mortgage of $300,000; your monthly payment would be about $1,610. In contrast, a 5-year ARM of $300,000 with an introductory rate of 4% would have a monthly mortgage payment of approximately $1,432. Over the course of the first five years, you’d save a total of around $10,680.
Pros & cons of a 5-year adjustable-rate mortgage
Pros of a 5-year ARM
A 5-year ARM offers these benefits:
- It has a lower initial interest rate and, therefore, a lower monthly mortgage payment in the early term than a fixed-rate mortgage.
- It allows you to save money that can be invested or put it towards financial goals like saving for retirement or paying off credit card debt.
- Because the initial rate is lower, you may be able to qualify for a more expensive home.
Cons of a 5-year ARM
The primary drawbacks of a 5-year ARM include:
- The mortgage rate could increase substantially when the introductory period ends, raising your monthly mortgage payment.
- Your monthly payment may change frequently after the first five years, making it more difficult for you to manage your household budget.
- ARMs are more complex loan products with respect to fees, caps, and structures than fixed-rate mortgages.
When a 5-year ARM might be best
First-time home buyers are often good candidates for a 5-year ARM, since many entry-level buyers are looking for a starter home that they’ll live in for a few years before they upsize. That means their time horizon for how long they plan to own the home can align nicely with a 5-year ARM — and the monthly savings that comes with it.
ARMs are particularly attractive in today’s high-interest lending market, where the average 30-year fixed-rate mortgage clocked in at a 5.22% rate the week of August 11, according to Freddie Mac’s weekly Primary Mortgage Survey.
The average 5-year ARM, meanwhile, has a lower introductory rate of 4.43%. And some economists predict mortgage rates will rise even higher as the year goes on because of inflation and growing fears of a recession.
It’s no surprise, then, that demand for ARMs is up. According to the Mortgage Bankers Associations, ARM applications represented 7.4% of all purchase applications the week ending August 5, up from 3.1% at the beginning of the year.
A 5-year ARM can also be a wise option for a home buyer who is planning to sell their new home or pay off their mortgage in full within the first five years, before their loan’s low introductory interest rate expires.
5-year ARM FAQs
Is a 5-year ARM a good idea?
A 5-year ARM may be a great option if you know that you’re going to sell your home, pay off the mortgage, or refinance within five years. Because the introductory rate is usually significantly lower than 30-year fixed mortgage rates, an ARM can save you a lot of money in interest over the first five years.
What is a 5-year ARM FHA loan?
FHA-backed mortgages are home loans secured by the Federal Housing Administration. They’re geared toward consumers with poor credit or little savings for a down payment; they only require a minimum 580 credit score and down payments can be as low as 3.5%.
The FHA offers what it calls “hybrid ARMs” — adjustable loans with a low initial interest rate for the first 3 , 5, 7, or 10 years. After the initial period, the interest rate adjusts. On a 5-year FHA adjustable-rate loan, the interest rate will increase one percentage point annually after the first five years, but the mortgage rate hikes are capped at five percentage points over the life of the loan.
Is an adjustable-rate mortgage recommended for first-time home buyers?
First-time buyers are often well suited for ARMs, mainly because they’re likely to move in a few years to a larger home, meaning they’ll be able to sell their house before their ARM’s interest rate can increase.
Is a 5-year ARM a conventional loan?
Generally, 5-year ARMs are conventional loans, meaning they conform to loan limits set by Fannie Mae and Freddie Mac. (ARMs offered by the FHA or Department of Veterans Affairs are an exception.) In most cities, a conventional/conforming loan is capped at $726,200 for a single-family home, though loan limits may be higher in areas with notably high home prices.
What are 5-year ARM rates?
According to Freddie Mac’s weekly interest rate tracker, the average 5-year ARM is typically 1 to 2 points lower than 30-year fixed rates. Though, of course, your actual rate may vary depending on factors like your credit score, loan amount, and down payment.