An adjustable-rate mortgage is an alternative to the more typical fixed-rate home loan. As of 2015, typical ARMs have a set period of time upfront where your interest rate is locked. In a 5/1 ARM, the initial period is five years. In a 7/1 ARM, the initial interest period is seven years. A primary reason people choose an ARM is because the opening interest rate is lower than the starting rate on normal fixed-rate loans. However, rates can spike after the initial fixed-rate period if the prime interest rate rises.
5/1 ARM Overview
Like common fixed-interest loans, you can get standard ARMs with a repayment term of up to 30 years. Relative to a 5/5 ARM, a 5/1 ARM has a lower interest rate and annual percentage rate. On top of the 1 to 2 percent you may save compared to a fixed loan, a 5/1 ARM can save a borrower hundreds of dollars during the first five years of a low interest. A 5/1 ARM may offer a 3 percent rate at the same time a 30-year fixed loan has a 4.5 percent rate, for example.
5/5 ARM Overview
Like a 5/1 ARM, a 5/5 ARM normally has a much lower interest rate and APR than a 30-year fixed loan. Some lenders pay mortgage insurance premiums on a 5/5 ARM for good-credit borrowers who put less than 20 percent down on their home. On most fixed-rate loans, buyers have to pay for this insurance. A 5/5 ARM fits best for people wanting a home that is $417,000 or more, or who don't have a 20 percent down payment, according to GTE Financial.
Functionally, the most vital difference with the 5/1 and 5/5 ARM is the more regular interest-rate adjustments on the 5/1 loan. When interest rates decline from year-to-year, it benefits the borrower to have this adjustment. When rates increase, a rapid adjustment leads to a spike in a homeowner's interest and loan payment. With a 5/5 ARM, a borrower benefits from delayed adjustments when rates rise. If rates decline, the borrower is at a disadvantage relative to a 5/1 loan.