If you are familiar with adjustable-rate mortgages (ARMs), you have probably heard of the 5/1 ARM or even the 10/1 or 1/1 ARM. There is a newer ARM loan available that is growing in popularity: the 5/5. Here’s everything you need to know about this unique loan product.
What is it?
The first number in an ARM refers to how long the initial fixed-rate period is, and the second number tells how often the mortgage rate can adjust thereafter. Thus a 5/5 ARM is one with a fixed interest rate for the first 5 years that will adjust every 5 years from that point on.
While having an adjustable rate can be hard on your budget, there are certain caps and limits built into the loan. If you know these upfront, you can make sure you can afford your loan, even at the highest possible rate. The average rate cap on the first rate adjustment is 2%. If you had an initial interest rate of 3.5%, for example, the most your rate could rise or fall during year of the loan would be 2%, pushing it to 5.5% at the upper limit.
There are also periodic rate caps and lifetime rate caps. The periodic is also generally about 2% and applies to subsequent rate increases. Over the lifetime of the mortgage, the rate can only grow up to a certain level, often around 5%. If your original rate was 3.5% and you have a lifetime cap of 5%, then 8.5% would be the highest rate your loan could ever reach.
All ARMs are adjusted based on a certain market index, commonly the LIBOR index. Most ARMs come with a rate floor requirement or margin. This is typically 2%. This protects the lender in case the market index ever falls too low. If your initial starting rate is low, it is possible that you will never see your rate go down, even if the market index falls.
The main benefit of any ARM is that the initial rate is usually lower than those of fixed-rate mortgages. 5/5 ARMs are great for those who don’t plan to stay in their home for more than a decade, but perhaps more than 5 years. This gives them only one rate adjustment period in that time and plenty of opportunity to refinance or sell. Compared to the 5/1 ARM where the rate adjusts annually after the first 5 years, the 5/5 limits the amount of extra interest you might pay over the next half-decade.
Even if you plan to stay in your home a long time, the 5/5 means fewer adjustments, giving you more time to prepare for the next potential increase.
There are potential downsides to this loan product, however. The initial rate on 5/5 ARMs tend to be slightly higher than those of 5/1 ARMs. For example, if you could get a rate of 2.5% on a 5/1, you might get a 3.5% on a 5/5. If you were to move or refinance within the first 5 years, you would save more money with the 5/1.
It is also possible that the rate caps could be higher on a 5/5. Where a 5/5 ARM might have a first rate adjustment cap of 2%, a 5/1 ARM might be only 1%. Of course, the 5/1 can continue to adjust each year after that, but there is still the risk that the 5/5 rate might be higher than the 5/1 for the next several years.
The 5/5 ARM can be a safer product in some respects than ARMs that adjust every year. It depends on how long you plan to stay in your home and what is happening with the interest rate climate over the life of your loan. Be sure to understand all ARM caps and limits before making your decision.
If you have questions or think that a 5/5 ARM mortgage might work for you or someone that you know - give Island Home Capital, Inc. a call today at 808-326-2444 and mention that you're interested in a 5/5 ARM mortgage loan.