Homebuyers or homeowners interested in refinancing a large mortgage, one above the conforming loan limits set by Fannie Mae and Freddie Mac, may want to consider a jumbo 5/1 ARM. When interest rates rise, an adjustable-rate mortgage can be one way to make the monthly mortgage payments more affordable.
Definition of a jumbo 5/1 ARM
An ARM has an interest rate that fluctuates during the loan, which also means the monthly principal and interest payments will change. The interest rate will stay the same during the initial loan period, for example, for five years on a jumbo 5/1 ARM, then adjust on a yearly basis for a 5/1 ARM.
Jumbo ARMs are adjustable-rate loans that exceed the conforming loan limits set by Fannie Mae and Freddie Mac, generally $417,000 for a one-unit home, although the limits are raised in high-cost housing areas in the continental U.S. to as high as $729,750.
ARM borrowers need to understand several aspects of these home loans:
- Index. ARM interest rates are tied to a specific index, such as the Libor, and will adjust according to change in the interest rates on these indices.
- Margin. The margin remains fixed for the entire ARM term. This is the difference between the index and the mortgage rate.
- Caps. Caps establish the maximum possible increase in the mortgage rate over the entire loan term as well as the maximum possible interim interest rate.
Advantages of a jumbo 5/1 ARM
A jumbo ARM will have lower interest rates during the initial loan period, making the monthly payments more affordable and sometimes allowing the borrower to qualify for a higher loan amount. A small decrease in the interest rate can have a big impact when taking out a large loan.
Disadvantages of a jumbo 5/1 ARM
The biggest risk of a jumbo ARM is that interest rates may rise and trigger unaffordable monthly payments for principal and interest on the mortgage. If the borrower cannot afford the payments, refinancing to a lower rate may not be an option.
Jumbo 5/1 ARM borrowers
Borrowers who know they will sell their home or are certain of a higher income at the end of the fixed-rate term on an ARM are the people most likely to choose an ARM. For example, borrowers who already own a retirement home and have a firm retirement date can benefit from lower payments with an ARM until they are ready to sell. Borrowers who choose a jumbo 5/1 ARM should use a mortgage calculator to estimate the highest possible mortgage payment to be sure they can afford the payments.