What Is a 5/1 ARM? Your Guide to 5-Year Adjustable-Rate Mortgages

One way to save on interest, at least at the beginning of your mortgage, is to get a 5/1 ARM. With a 5/1 ARM, you have a fixed rate for the first five years of your mortgage, with the rate adjusting every year after that.

A 5/1 ARM can help you get a lower interest rate initially, making it attractive to certain homebuyers.

What is a 5/1 ARM loan?

When you get a mortgage, you often choose between a fixed-rate and an adjustable-rate loan. An adjustable-rate mortgage, or ARM, is a home loan where the interest rate has the potential to change over time.

A 5/1 ARM is a type of hybrid mortgage that includes a fixed rate for a set period of time before switching to an adjustable rate.

Here’s what the two numbers indicate:

1. The first number: Represents the number of years in which your interest rate remains fixed.
2. The second number: Reflects how often the rate will adjust annually after that fixed period.

For example, if you had a 5/1 ARM with a 30-year term, you’d have a fixed interest rate for the first five years. After that, your rate and payment will change once a year for the remaining 25 years.

Learn More: What Is a Mortgage Rate and How Do They Work?

How a 5/1 ARM works

A 5/1 ARM loan works by starting with a fixed interest rate and switching to an adjustable interest rate later. Your rate is fixed for five years, and then, depending on market rates, it moves higher or lower every year after that.

There are usually caps on how high the interest rate can adjust. Each time your rate adjusts, your payment will also adjust to ensure you pay off your mortgage on time.

Important mortgage terms to know when shopping

Your adjustable interest rate is based on a specific index and margin. Each year, your lender will look at the index specified in your paperwork and add the required margin — this will be your new rate for the coming year.

Here’s a quick breakdown of what the index and margin are and how they work:

• Index: The benchmark interest rate based on current market conditions. In the past, many mortgages used the London Interbank Offered Rate (LIBOR), but that was phased out in favor of the Secured Overnight Financing Rate (SOFR) as of June 30, 2023. Other indexes that might be considered include the Cost of Funds Index (COFI) and Constant Maturity Treasuries (CMT).
• Margin: This is the fixed amount that’s added to the index by your lender, giving you your interest rate for the year. For example, if you have a margin of 3% and your rate adjusts based on the SOFR — and the SOFR is at 0.15% — your new mortgage rate would be 3.15%.

Interest rate caps

The good news is that your mortgage interest adjustment is limited. So, you won’t see your rate shoot up out of nowhere.

In many cases, a lender will issue a cap based on the first adjustment, subsequent adjustments, and a lifetime cap. A common cap is the 2/2/5 cap. Here’s how this cap structure works:

• Initial adjustment cap: The first number represents the initial adjustment cap. This is the first time the lender has changed the rate after the fixed rate ends. So, in this case, the rate can’t be more than two percentage points higher than your initial rate, no matter how much interest rates have increased.
• Subsequent adjustment cap: The second number reflects the cap on the following adjustments. Once again, in this case, the adjustment can’t go higher than two percentage points.
• Lifetime cap: The final number shows the lifetime cap. As long as you have the loan, the interest rate can’t go five percentage points beyond your initial rate if you have a 2/2/5 cap.

Loan terms

5/1 ARMs typically come with an overall term of 15 years or 30 years. The interest rate remains fixed for the first five years and then adjusts every year after that for the remainder of the loan.

Let’s run through a quick example to better understand what you’d pay each month (in principal and interest only) with a 5/1 ARM vs. a fixed-rate mortgage.

Pros and cons of a 5/1 ARM

The low initial interest rate of an adjustable-rate mortgage makes it an enticing option, and it could make homebuying more affordable.

But you’ll have to be comfortable with the uncertainty. If rates rise, you might get saddled with a higher mortgage payment and have to pay more interest in the long run.

When to consider a 5/1 ARM

Opting for a 5/1 ARM makes sense if you don’t plan to live in your home long-term. If you intend to sell the home within five years, you can take advantage of the ARM’s lower initial fixed interest rate and lower initial monthly payment.

An ARM is riskier if you’ll be in the home for five years or more. Since the rate can fluctuate, you might have a higher interest rate and minimum monthly payment.