A 5-year mortgage, also known as a 5/1 ARM, is a hybrid mortgage with a fixed interest rate for the first 5 years of the loan, and an adjustable interest rate for the rest of the repayment term. This type of mortgage combines an adjustable rate mortgage (ARM) with a fixed mortgage. The benefit of this type of a loan is that it offers a fixed low interest rate for the first 5 years. The risk is that, after the initial 5 years, the interest rate will be adjusted every year, and will most likely increase, making your monthly payments rise. The increase or decrease in interest rates is determined by an index based on the returns of investments, such as US Treasury securities, and changes in international interest rates.
A hybrid mortgage, such as the 5/1 ARM, features lower interest rates than fixed mortgages, but higher interest rates than a standard adjustable rate mortgage. It gives you the safety of knowing what your interest rate will be for the first 5 years, but the downside is that you won’t know if your payment will go up or down each year for the remainder of the loan.
The Advantage and Disadvantage of a 5 Year Mortgage
After the first 5 years, the owner can keep the 5/1 ARM mortgage and keep making payments with an adjustable interest rate, or refinance into a new mortgage. 5/1 ARM mortgages are ideal if you decide to refinance before the end of the initial 5 years of your mortgage.
The disadvantage to a 5/1 ARM mortgage is that, after the initial 5 years have passed, you could see your payments go up by a lot, depending on what the mortgage interest rates will be then, or you can’t qualify for a refinance anymore.
The most important thing when looking at a 5-year fixed loan is to make sure that it has low caps on every interest rate change and the duration of the loan. To be certain that you will save the most money, make sure that the 5-year loan has low interest rate caps between every rate change and overall interest rate cap. Using an online mortgage calculator can help you find out how big your payments will be, given your interest rate caps for each 6 month period.
You must weigh your options carefully before deciding to go with any mortgage, but you should be extra careful if you decide to go with a 5/1 ARM. While it can feel like the right choice due to the advantages that it has for the first 5 years, it can quickly become a burden if you haven’t taken everything into consideration before jumping.