An adjustable-rate mortgage (ARM) comes with an interest rate that changes over time. Typically, you begin an ARM paying a lower, fixed rate for a set period of time. After that fixed-rate time expires, your rate adjusts to the market rate, either higher or lower. The most common types of ARMs include 3/1, 5/1, 7/1 and 10/1 loans.

What is a 5/1 ARM?

A 5/1 ARM is one type of adjustable-rate mortgage. The “5/1” refers to the length of the fixed-rate period and the frequency of rate changes, respectively. The “5” is the fixed-rate period of the mortgage: the first five years. The “1” is how often the interest rate adjusts after that: once per year.

Another common mortgage is the 5/6 ARM, which adjusts every six months after the initial five-year period.

How does a 5/1 ARM loan work?

The clock starts ticking on your 5/1 ARM as soon as you close the loan. if you were to close the mortgage in July of this year, for example, your rate wouldn’t change again until five years later.

When this adjustment happens, the lender recalculates the interest on your loan going forward depending on how the rate has changed, up or down. One year later, your loan will adjust again, and the process will repeat to the end of the loan term.

The main takeaway for you: If your rate goes up, your monthly payment will also go up. The inverse is also true.

ARMs are uniquely structured to allow for a lower introductory rate and subsequent adjustments, but your rate can’t just keep climbing indefinitely. On your closing documents, you’ll likely see the following:

  • Introductory or “teaser” rate, the interest rate you’ll pay during the initial fixed-rate period
  • Adjustment intervals, the frequency at which the rate can change
  • Initial adjustment cap, the maximum amount by which the rate can rise at the first adjustment
  • Periodic rate cap, the maximum amount by which the rate can change each time it resets
  • Lifetime cap, the maximum amount by which the rate can change over the life of the loan

What index does the 5/1 ARM use?

The index is a major factor in determining the rate you pay. ARMs are typically tied to either the yield on 1-year Treasury bills, the 11th District Cost of Funds Index (COFI) or the Secured Overnight Financing Rate, also known as SOFR. Your mortgage rate is determined by the rate of the index plus a margin determined by the lender.

What are the pros and cons of a 5/1 ARM?

Pros

  • Cheaper to start: The main benefit of a 5/1 ARM is more affordable monthly payments, at least initially, compared with a 30-year fixed mortgage.
  • More house: The lower payment could help you take on a bigger mortgage and get a larger or more ideally-located house.
  • Your rate could decrease after the initial period: If interest rates are falling, your monthly payment will also decrease after the initial period, and potentially during future resets.

Cons

  • Could cost you much more: The big disadvantage of the 5/1 ARM is exposure to higher rates after the fixed period is up. If rates have risen, your payment will increase.
  • Complexity: There’s more moving parts to an adjustable mortgage than a fixed one. Rate caps, indexes, resets — this can be pretty technical stuff for the average borrower.
  • Interest-only trap: Some ARMs allow you to only make interest payments, not principal, in the initial period. That can allow you to stretch your budget and lower your payment, but after the fixed period your payments will be much higher to include the principal. Aside from hurting your budget, if home values drop, you could find yourself underwater on the loan.

How 5/1 ARMS compare to other loans

5/1 ARMs are popular, but there are many other types of mortgages.

5/1 ARM vs. 10/1 ARM

The 10/1 ARM is similar to the 5/1 ARM, except the initial rate is fixed for the first decade rather than five years. Generally, the interest rate on the 10/1 will be a little higher than the one on a loan with a shorter-term initial period, reflecting the longer period the initial rate is locked in.

5/1 ARM vs. 7/1 ARM

The 7/1 ARM is the same as 5/1 ARM in all respects, but the initial rate adjusts after the first seven years rather than the first five. The rates on these will be higher than the 3/1 or 5/1. This longer fixed period could be a good choice if you know you want to move or refinance within seven years.

5/1 ARM vs. fixed-rate mortgage

The introductory fixed rate on a 5/1 ARM is usually much lower than the one on a 30-year, fixed-rate loan. That translates to a lower monthly payment, at least initially.

Of course, the drawback is uncertainty. After five years, your ARM rate and monthly payment could rise. With a fixed-rate loan, you’ll know exactly how much you’ll pay over the life of the loan, making the payments easier to budget for.

When to consider a 5/1 ARM loan

If you’re in the market for a mortgage, a 5/1 ARM might be a good fit in a few situations:

  • You plan to refinance or sell soon. If you don’t plan to keep the loan for more than five years, you’ll never deal with a rate adjustment. You’ll need to have a concrete plan for how you’ll get out of the loan, however, whether that’s moving or refinancing. If you want to refinance, keep in mind you’ll need to be able to qualify for it, as well as pay closing costs.
  • You expect your income to increase over time. If you know you’ll be bringing in more income five years from now, you might be able to handle a potential increase in payment. This might be the case if you’re a doctor just coming out of medical school, for example, or a lawyer, or in some other similar profession with a lucrative earnings horizon.
  • Your budget supports the maximum payment. If you’re well off financially, a bump in rate and payment might not matter much in your budget. This lowers the risk of rate adjustments considerably — but it also means you might not have as much left over for other financial goals, like investing or saving for retirement.