The 5/1 ARM is a type of adjustable-rate mortgage in Arizona that offers a fixed rate for the introductory part of five years. After that, it switches to the adjustable part for the remaining term of the loan. The second part after the keystroke is meant to denote how many times the rate is adjusted per year during the adjustable phase. That means that it is adjusted once per year for the remaining 25 years of the loan. The variable interest on the 5/1 ARM every year is determined by several factors depending on the lender and jurisdiction. These factors would be the LIBOR, or cost of funds index. The index may rise over the interest rating the buyer initially paid for the loan. In such a situation, the interest rate tends to increase. Though, should it decrease, the interest rate will also go down.
Even though the buyer gets into an ARM loan in Arizona with smaller payments, should they plan to remain in the home for more than five years, it is possible to pay more for the mortgage over the lifespan of the loan. It is more than they would for simple fixed-rate loans. An increase in the interest would consume anything saved during the introductory phase.
Pros of the 5/1 ARM
- There is a low introductory rate: The initial interest rate set at the beginning for the customer is known as the teaser rate, and it tends to be lower than the fixed-rate mortgage. The 5/1 ARM is most likely going to have a 1 percent rate lower than a fixed rate for the initial five years of the loan.
- Lower monthly payment: a small interest at the start of the mortgage is an indication the mortgage payments are lower for the term of the mortgage. This is especially if there is a stable market overall. Monthly premiums are dependent on the trend set during this time.
- Large potential for savings: when considering the rate for the five-year adjustable mortgage, it would seem there is a high potential for savings. Rates for the mortgages are smaller compared to those provided by the fixed mortgage loans. Should the borrower compare the rates for the fixed mortgages to each year of the ARM, there is going to be a percentage difference. That means the borrower will have more revenue left over for disposable income, and some of this can go towards their savings schedules.
- It is possible to afford an expensive home: considering the rate is lower with the ARM, the debt to income ratio tends to be lower. That means allowing for the qualification to get a home that was not in the package or allowed by the credit rating.
- Caps: the adjustable-rate mortgages have a cap for the interest rate as well as the mortgage payments. These are caps which make sure the interest rate and the payments do not go a level higher than the predetermined numbers.
- Time is on the side of the borrower: should the buyer not plan to live in the same property for 30 years, then the fixed-rate mortgages are counterproductive. Borrowing using a 30-year term which would finance a home that will only be useful for the first five or 6 years is a losing bet. The result is penalties in thousands of dollars, and the borrower will not have a lot of equity in the home by the time they sell it. The 5/1 ARM allows the owner to get some equity in the first five years and be able to refinance without unexpected fees cleanly.
Cons of the 5/1 ARM
Because of their nature to be unstable, the 5-year ARMs tend to be unpredictable over the long term. During the introductory phase, the monthly payments are going to be static, so one will not know how the interest rate is going to behave over the long term. A lot of adjustable-rate mortgages are linked with a particular index. These indexes are the interest rates that the banks would charge when loaning money among themselves. Should the indexes react to market pressure of the Federal Reserve interest rates, it will significantly affect the monthly rate the borrower has to pay going forward. They may end up paying a significant percentage of more money every month. As such, the borrower may find themselves trapped within unaffordable rate hikes because of the market forces.
Refinancing may not help
Because of the ARM complexities, most mortgage sellers use refinancing as a selling point to people who are not well versed in the language. They may believe they can get an ARM to take advantage of low-interest rates and refinance, so they get another ARM or a fixed mortgage after the introductory part. Though should the interest rates have already increased since the beginning of the loan, and then the rates will end up being higher than they were in the past.
Not every cap is created the same
Caps may differ over the life of the loan. The initial adjustment could increase to a level of 5% though the next adjustments would be capped at 1%. Should this be the case on the ARM mortgage, then the borrower needs to prepare for a swing in the monthly premiums after the reset.
The bottom line with the 5/1 ARM is that the borrower needs to be sure about what they are getting into. The lender needs to be able to explain the worst-case scenarios and hiccups, which may occur. This is just, so the buyer is not blindsided. The majority of borrowers look at these with the assumption they are going to be in a better position to absorb the increases, whether it is 5 or 10 years in the future.