Mortgage basics: 5/1 ARM vs. 15-year fixed-rate mortgage


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Some mortgage products are broadly similar instruments, but a 5/1 ARM and a 15-year fixed are about as different as an apple and an orange.

While both tend to offer rock-bottom interest rates, and they have different terms and risks associated with them. Here’s how they stack up—and when you might want to pick one over the other.

Pros and cons of a 5/1 ARM

During its 30-year term, the 5/1 ARM, or adjustable rate mortgage, has a fixed rate for the first five years and annual rate adjustments each year for the following 25 years. The benefit of the loan is that the initial, five-year rate is generally lower than that of a standard, 30-year fixed mortgage and competitive with a 15-year fixed. For instance, a 30-year fixed mortgage is currently at 4.04 percent, compared with 3.49 percent for a 15-year fixed and 3.46 percent for a 5/1 ARM.

Monthly payments, however, are much lower with a 5/1 ARM than with a 15-year fixed-rate mortgage, due to the former’s 30-year term. This means that you could possibly afford to buy a more expensive house with a 5/1 ARM than you could with a fixed-rate mortgage. The downside: Once those five years elapse, the rate—and your monthly payments—could go up.

While most 5/1 ARMs offer consumers some protections, including caps on interest-rate hikes, signing up to pay more in later years is a risk. It’s essential to make sure you will be able to afford payments even if rates go up. If you plan to move or refinance your mortgage before the first five years end, however, a 5/1 ARM could work well for you.

Pros and cons of a 15-year fixed mortgage

As the name suggests, a 15-year mortgage is paid off in half the time of a standard, 30-year fixed-rate mortgage or a 5/1 ARM. The benefits of a 15-year fixed include:

  • A low interest rate. Since lenders take on less risk with a 15-year loan, they typically offer an interest rate competitive with the initial rate of a 5/1 ARM.
  • More savings in the long run. Since you pay down your principal faster, you spend significantly less in interest over the years. For instance, with a $200,000, 15-year fixed loan at 3.49 percent, you’d pay $57,181 in interest over the life of the loan. With a 30-year fixed mortgage at 4.04 percent, you’d spend 2.5 times that amount in interest. A 5/1 ARM, meanwhile, could end up costing you more than three times that amount in interest, depending on the terms of your mortgage.
  • Easier budgeting. Since a 15-year fixed mortgage has a set rate, you don’t have to worry about the possibility of bigger monthly payments.

Of course, there’s a major downside: Your monthly payments will be larger. In the example above, you would fork over $1,429 in monthly payments with a $200,000 15-year fixed-rate loan, compared to just $893 in initial payments with a 5/1 ARM.

The bottom line

Different mortgage products help consumers achieve different goals. If you want to pay the least amount possible in interest, and secure a mortgage-free future sooner, a 15-year fixed-rate mortgage is a good choice, particularly if you can lock in a low rate. But if you have other financial obligations right now, such as paying for college or buying a new car, you might want lower monthly payments. You can always make an extra mortgage payment from time to time, to pay down your loan faster.