What is a 5/1 ARM?

A 5/1 ARM is a common type of adjustable-rate mortgage; this is a loan that adjusts its rate periodically. The 5/1 refers to two key things for borrowers: the 5 refers to the fixed period of the mortgage — the first five years — and the 1 refers to how often the interest rate adjusts after that, usually annually. Another common mortgage is the 5/6 ARM, which adjusts every six months after the initial period.

When does a 5/1 ARM adjust?

The clock starts ticking on your adjustment when you take out the 5/1 ARM. So if you were to close your loan on July 1, 2022, the first rate adjustment will occur July 1, 2027.

When this adjustment happens, the lender recalculates the interest on your loan going forward depending on how the rate has changed, up or down, which could be higher or lower than the initial rate. Exactly one year later, your loan will adjust again, and the process will repeat to the end of the 30-year period.

What index does the 5/1 ARM use?

The index is a major factor in determining the rate you pay. ARMs in the past had been tied to either the yield on 1-year Treasury bills, the 11th District cost of funds index (COFI) or the London Interbank Offered Rate (LIBOR). LIBOR has been phased out in favor of a new index: the Secured Overnight Financing Rate, also known as SOFR.

The mortgage rate is determined by the rate of the index plus a stated margin. For example, in May 2022, SOFR reached 0.80 percent. If the spread on the SOFR ARMs is 2.75 percent, then the loan rate would be 3.55 percent.

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 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 is a good choice for people who know they want to move or refinance within seven years.

Keep in mind that the rate resets every year after the initial fixed period based on the stated index and margin. ARMs have a cap on how much the interest rate can rise over the life of the mortgage or during the annual reset.

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

Pros

  • Cheaper: The main benefit of a 5/1 ARM is more affordable monthly payments compared with a 30-year fixed mortgage. Interest rates for ARMs in recent months have hovered a full percentage point lower than comparable 30-year fixed loans.
  • More house: The lower payment allows you to take on a bigger mortgage and get a larger or better-located house. However, it’s recommended that you only get a loan amount that you can realistically afford. It’s risky to take on a bigger loan amount if it’s possible your monthly payment will be unaffordable after the initial period ends.
  • Your rate could decrease after the initial period: If interest rates are falling, then your monthly payment will also decline 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 homeowner.
  • Interest-only trap: Some ARMs allow you to only make interest payments and 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. If home values drop, you could find yourself underwater on the loan.

Correction, Feb. 10, 2023, 3:30 pm ET: A previous version of this article incorrectly stated that the SOFR was 1.05 percent in May 2022. This article has been corrected to say that SOFR was 0.80 percent in May 2022.