”It often takes five to six years before the cost paid for points upfront is recouped through the lower monthly payments,” says McBride. “Taking a 5/1 ARM makes sense if you plan to move within the next five years, but paying points to further reduce the rate would take longer than five years to recoup.
ARMs typically have fixed-rate introductory periods of three, five, seven or 10 years, so they “can make sense for a borrower with plans for a shorter time frame in their new home of five to 10 years, where they would likely sell before their rate resets,” says Kan. You're comfortable with the risk.
Monthly payments might increase: The biggest disadvantage of an ARM is the likelihood of your rate going up. If rates have risen since you took out the loan, your payments will increase when the loan resets.
Lower Initial Interest Rate
Because the interest rate can change in the future, an ARM is structured so that you can get a lower interest rate for the first several years of the loan than you would if you were to go with a comparable fixed rate.
ARMs make home ownership more affordable—at least initially. Throughout 2023, mortgage rates steadily ticked upward, pricing many prospective homebuyers out of the market. The interest rate on a 30-year fixed-rate mortgage began the year around 6.58%.
An ARM might be a good idea if you: Plan to sell your home within a few years. Think interest rates will go down considerably in the long run. Expect your income to increase before your ARM adjusts.
Fixed-Rate Mortgages May Be Good For
Tight monthly budgets: ARMs have low initial interest rates, but after this period ends, rates can be unpredictable. Fixed-rate loans allow you to predict what you'll pay in interest and principal each year without factoring in market rates.
You can refinance an adjustable-rate mortgage (ARM) just like you could with any other type of mortgage. The option to refinance could make an ARM appealing if you're looking to buy a home and want to start with the lower rate—and monthly payment—that ARMs can offer, but you're worried about future rate increases.
You can refinance an ARM loan and by doing so, you'll replace your existing mortgage with a new one. In this case, it can be either another ARM or a fixed-rate mortgage.
Key takeaways. A 5/1 ARM loan provides an initial fixed-rate period of five years, after which the interest rate adjusts yearly depending on current market rates. ARM loans have rate caps, a ceiling for how high your interest rate can go once the introductory fixed-rate period ends.
The main difference between ARMs and fixed-rate mortgages is that ARMs have an interest rate and monthly payment that can go up and down over time, whereas fixed-rate mortgages have an interest rate that never changes, so the monthly principal and interest payments stay the same.
You'll pay way more interest with an ARM—maybe even more than you originally owed on the house! So if you take out an ARM, you're betting against yourself and your long-term financial security. And 30-year fixed-rate mortgages aren't much better. Something similar happens with fixed-rate conventional mortgages.
Not according to the research, which shows today's ARMs are no riskier than other mortgage products and that their lower monthly payments could increase access to homeownership for more potential buyers.
As mentioned above, switching to a fixed interest rate will help keep your monthly payments stable. If you want to avoid an ARM's adjustment period, you could use a refinance to change the type of home loan you have. You want a different repayment period. Refinancing your ARM can allow you to change your term.
If you plan to stay in your home for a long time, a 30-year fixed mortgage is the better option. While a 10/1 ARM may offer initial savings, the potential for higher interest rates in the future could outweigh these savings if you end up keeping the loan for an extended period.
LIBOR is the name for an index of interest rates used in loans across the country and across the globe. LIBOR expires on June 30, 2023, as part of a transition that has been planned for several years. Adjustable-rate loans based on LIBOR must change to a replacement index.
Adjustable-rate mortgages
Lower initial rate: During the initial fixed period, the interest rate is usually lower than what you'd pay for a fixed-rate mortgage. That can save you money, assuming the duration of the fixed period aligns with your plans.
Most lenders require the borrower to purchase PMI unless they're able to make a down payment of 20%. Most of our Adjustable-Rate Mortgages don't require PMI, which saves you money each month.
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. To see what your monthly payment would be at a certain interest rate, use the calculator below.
The initial rate for a 5/1 ARM is generally lower than the rates for 15-year or 30-year fixed-rate mortgages, which are aimed more for buyers hoping to stay in a home for a long time. With a 5/1 ARM, you'll lock in a lower interest rate for the first five years. After that, the interest rate changes.
Some ARMs, especially interest only and payment options, charge fees if you try to pay off the loan early. That means if you decided to sell your home or refinance it, you will pay a penalty on top of paying off the balance on your loan.
1- and 3-year ARMs may increase by one percentage point annually after the initial fixed interest rate period, and five percentage points over the life of the Mortgage.