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5-Year Arm

A 5-year adjustable rate mortgage (ARM) has a low fixed interest rate for the first 5 years, saving you money compared to a 30-year fixed loan. After that initial period, the interest rate of the loan can change each 6-12 months for the remaining life of the loan, which is typically 25 additional years.
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What is a 5-year ARM?

A 5-year ARM (adjustable rate mortgage) comes with a low introductory fixed interest rate for the first 5 years of the loan, saving you money compared to a 30-year fixed mortgage. After the initial period, the rate can change (adjust) once each six or 12 months for the remaining life of the loan. The full term is typically 30 years.

This type of loan is often listed or displayed as 5/1 ARM. This indicates that the mortgage has a fixed rate for the first five years and then an adjustable rate every (1) year afterward. This is very important to understand because as a result of this adjustable rate, the monthly payment may change from year to year after the first five years.

There is also a 5/6 ARM, meaning the rate can change every six months after the initial fixed-rate period.

There is a newer type of 5-year ARM as well, called the 5/5 ARM. This loan is fixed for five years, then adjust every 5 years thereafter. Homeowners who are worried about their payment changing every 6-12 months could opt for a 5/5 ARM for the peace of mind it brings.

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Special Features

  • More affordable homeownership: ARM loan programs offer lower rates during the first part of the loan compared to 30-year fixed mortgages. As of July 2022, the average 5-year ARM rate was 1.01% below the 30-year fixed average rate, according to Freddie Mac. That’s a $180-per-month discount on a $300,000 loan and would save a homeowner nearly $11,000 in the first five years of the loan.
  • Limits on rate increases: ARMs come with consumer protections called interest rate “caps.” These are limits on how far and how fast your rate can rise. A 5-year ARM with 2/1/5 caps, for instance, can rise only 2% at first adjustment, 1% at each subsequent adjustment, and no more than 5% during the life of the loan. This ARM, for instance, with a 4% initial rate could never rise above 9%.
  • Conversion: Some ARMs have a special provision that allows for the borrower to convert the ARM to a fixed-rate mortgage at designated periods during the life of the loan.
  • The rate could drop: If market rates drop during the adjustment period, your payment could go lower. A fixed-rate loan requires a refinance and thousands of dollars in fees to capture lower market rates. An ARM will float downward with the market if rates drop after the initial fixed period.

FAQ about 5 Year ARM

Why are they considered Hybrid Mortgages?

The 5 Year Arm or 5/1 ARM is considered a hybrid mortgage. This means that the loan combines the features of a fixed-rate mortgage (the first five years) and an adjustable-rate mortgage (for the remaining years).

What are the benefits of a 5 Year ARM?

Generally, an adjustable-rate mortgage gives you a lower rate than a 30-year fixed-rate loan. As of July 2022, the average 5-year ARM rate was 1.01% lower than the 30-year fixed, potentially saving a homebuyer $180 per month on a $300,000 loan, or about $11,000 in the first five years. These loans could be a great idea for someone who expects their income to increase in the future, or someone who plans to sell, refinance, or pay off the loan within five years.

How does an ARM work?

Typically, an ARM comes with these basic features:
Initial interest rate: This is the beginning interest rate on the ARM. It is often a fixed percentage rate for a period of time. In the case of the 5/1 ARM, this initial interest rate is fixed for a period of five years and then it enters into the adjustment period.
Adjustment period: This is the length of time that the interest rate is to remain unchanged. For example, in the case of a 5/1 ARM the initial adjustment period is five years and then adjusts once per year for 25 years until the loan is paid off. At the end of each period the rate is reset and the monthly loan payment is recalculated.
Index rate: Most ARMs are tied to an “index rate.” This is a benchmark by which they determine what the new rate will be adjusted to at the end of each adjustment period. The most common index used for mortgages is the Secured Overnight Financing Rate (SOFR).
Margin: This is the percentage points added to the index rate to determine the ARM’s interest rate during the adjustable period. For example, if the current index rate is 2.0% and the ARM has a 2.75 margin, the rate during the adjustment period would be 4.75% (index + margin).
Interest rate cap: Typically, ARMs have limits on how much interest rates can change at any adjustment period or over the life of the loan (often both). Caps are expressed as “initial adjustment cap/periodic adjustment cap/lifetime cap.” An ARM with 2/1/5 caps can’t rise or fall more than 2% at first adjustment, 1% each subsequent adjustment or 5% at any time during the life of the loan. Caps are an important risk mitigating factor to closely review if you consider an ARM.

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