This is simply a fixed-interest rate paid subsequently for five years but subjected to adjustment after the first five years. It is also known as a 5-year ARM or 5-year-fixed period ARM. From the name of the plan, 5 represents how often a fixed amount is paid while 1 represents how often the rate is adjusted after five years. In this case, the rate is adjusted once every year. As a result, there can be a drastic increase in monthly payments after the fixed five years period.
5/1 Hybrid ARM allows a fixed interest rate for the first five years of introduction, after which the interest rate is adjusted once every year.
Once ARM is adjusted, interest rates are adjusted based on the indexes they are tied to and their marginal rates.
At the introductory stage, homeowners often enjoy low mortgage payments.
Although the 5/1 Hybrid ARM is very popular and widely used, it is not the only available ARM. There are other arms like 3/1, 7/1, 10/1, these offer low-interest rates for the first three, seven and ten years respectively. After this, it changes every year.
5/1 ARM is adjusted in line with the index plus and the margin. It is very common with consumers. The low mortgage rate is usually significantly lower than the traditional fixed-rate mortgage.
There are several version of 5/1 ARM, they include 5/5 and 5/6. These two types allow an initial low-interest rate of five years after which the interest rate is adjusted every five years or six years.
There are other Hybrid ARM like 15/15, 2/28, 3/25. 15/15 featured a 15 years lower rate benefit after which the interest is adjusted every fifteen years, 2/28 features a two years low-interest rate, and then an adjustment at every twenty-eight years, while 3/25 features a three-year low-interest-rate benefit, after which interest rate is subjected to change every 25 years.
Note: all Hybrid ARM offers a fixed interest rate for a stipulated period of time, and then it is adjusted at a given period of time.
Example of 5/1 Hybrid ARM
In a situation whereby a 5/1 Hybrid ARM has a 3% index and a 3% margin, the interest rate would be adjusted by 6%.
However, the rate at which index on 5/1 Hybrid ARM can be adjusted is limited by an interest rate cap structure. Once the index rate gets to the highest level, the full index rate is tied to different indexes. Although this would vary every year, the margin is fixed for the entire loan period.
With 5/1 Hybrid ARM, a borrower can save significantly every month. For instance, if the home purchase price is $300,000, with a down payment of 20%(60,000). In a month, a borrower can save up to 50 to 150 basis points on loan. This is more than $100 in a month in payment on their loan of $240,000.
However, this is not the fixed rate, the borrower should expect an adjustment in their monthly payments. When the interest rate rises, a borrower can either sell the house or refinance.
5/1 hybrid ARM is extremely beneficial to homebuyers who intend to live for a period not more than the period of low-interest rate.