Pros and Cons of Paying off a 5/1 Arm in 5 Years

paying off a 5/1 arm in 5 years

Updated - 2022.02.16

Choosing the right mortgage can be overwhelming when you’re a new homeowner!

Mortgage lenders offer many financing options to buy or refinance a home, including various types of loans and terms like fixed-rate loans or an adjustable-rate mortgage (ARM) loan.

To make it easier, we’re discussing paying off a 5/1 ARM in five years and whether you can pay off a 5/1 ARM early.

What’s a 5/1 ARM, and How Does It Work?

paying off a 5/1 arm in 5 years

A 5/1 ARM mortgage loan offers homeowners a fixed interest rate for the first five years (or 60 monthly payments). 

After this first fixed-rate term, the monthly payments can go up or down in a variable rate based on the current interest rate. 

Here are a few important things to know:

  • The lifetime of a 5/1 ARM home loan can be 15, 20, or 30 years, and the interest rate may increase at any point, depending on real estate lending trends.
  • A fixed-rate 5/1 ARM is usually lower than a traditional 30-year mortgage term
  • Borrowers of loans like the 5/1 ARM have protections under the Federal Housing Authority (FHA), saying that mortgage lenders can only make a single rate adjustment a year.
  • A 5/1 ARM also has a lifetime cap on rate charges.

While mortgages like the 5/1 ARM typically see higher interest rates after the first five years, there have been times when the interest rates dipped lower.

Pros of a 5/1 ARM Loan 

Homeowners always dream about getting out of a mortgage faster. So here are the pros of doing that with a 5/1 ARM during the lifetime of this mortgage.

Low Fixed-Rate Phase Payments

Some lenders offer hybrid terms on ARM loans for more significant savings in the first fixed-rate period:

  • These include 3, 5, 7, or 10-year (3/1, 5/1, 7/1, or 10/1) terms.
  • Your rate gets locked into predictable low payments for however many years you select with an ARM loan.

Flexibility

Any ARM loan can offer flexibility, especially if your life changes with the first fixed-rate term. For example, if you need to sell your house sooner, you’ll still benefit from an ARM fixed-rate before any rate adjustments begin. 

Rate and Payment Caps

Several payment caps exist on ARM loans to limit the amount your mortgage rate can change with each adjustment and the total amount of rate changes allowed during the entire length of a loan.

Decreased Payments

We’ve seen interest rates fall in recent years. If this happens during the lifetime of your ARM loan, your monthly payments can drop.

Cons of Not Paying off a 5/1 ARM Loan

Because circumstances often change in life, it’s less realistic for owners to pay off a 5/1 arm during the initial fixed-rate period. Here are the downsides to an ARM loan after the fixed-rate phase has ended.

Increased Payments

Higher interest rates mean higher loan payments when the adjustable-rate period starts.

Unplanned Events

Unfortunately, statistics show that more people lose their properties when interest rates grow too high on a large mortgage sum. With an ARM loan, it’s crucial to plan for higher monthly payments.

Can You Pay Off a 5/1 ARM Loan Early?

paying off a 5/1 arm in 5 years

Any loan can be paid off early by a homeowner, but many loans, including ARMS, have built-in prepayment penalties.

Unfortunately, this means that you get charged a fee if you pay the loan off, sell your home, or attempt to refinance your loan.

However, as of January 10, 2014, the Consumer Financial Protection Bureau set rules limiting prepayment penalties. So make sure to tell your lender that you know limitations apply.

You can also search for lenders who may not charge prepayment penalties if you intend to sell your home or refinance your loan within the first five years of a 5/1 ARM mortgage.

Paying off a 5/1 ARM in Five Years

Paying off a 5/1 ARM during the first five years (this timeframe is often called the “teaser rate” period) may also incur penalties.

ARM loans can have complex rules depending on the lender, so it’s important to know your lender’s conversation rate rules, as well as the caps they must respect.

What Are ARM Caps?

ARM caps help homeowners because the caps are thresholds on how high an interest rate can go when the loan adjusts after the first five years.

  • The first adjustment rate is the first cap (usually no higher than 2%).
  • The next cap is a threshold for adjusting to the first cap interest rate. This cap is also called a periodic rate cap, limiting how high an interest rate can change per year.
  • The last cap sets a threshold for how high an interest rate can go during the loan’s lifetime.

What Are Adjustment Intervals?

An adjustment interval determines how often lenders can adjust the interest rate after the fixed-rate period on an ARM loan. 

For example, 5/1 means the fixed-rate period is five (5) years, and 1 means that lenders can adjust the interest rate once a year after the fixed-rate period.

Is a 5/1 ARM Right for You?

When market interest rates are low, the “teaser rate” on a 5/1 ARM mortgage can benefit homeowners!

But if interest rates are climbing, you may not see much savings in the monthly payments on an ARM loan during the teaser rate period.

Additionally, suppose you intend to sell a house shortly after the teaser rate period ends. In that case, you’ll probably lose the benefits of an ARM loan, and the valuation of your home could even decrease if demands become lower in real estate.

Final Thoughts on a 5/1 ARM Loan

If market conditions are favorable to homebuyers, you’ll have more benefits than risks paying off a 5/1 ARM in five years.

There’s a tremendous amount saved on interest over the lifetime of a loan, and you never have to worry about adjustable rates after the teaser period.

But generally, mortgage experts warn against this because life can be uncertain, and unexpected events can derail the best financial planning!

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