A 5/1 adjustable-rate mortgage (ARM) is a loan that has a fixed interest rate for the first five years and a rate that is adjusted every year after that based on market conditions and other factors. It can make home ownership more affordable, but it also comes with risk of your mortgage going up significantly after the five-year period.
We’ll cover everything you need to know about 5/1 ARM loans: what they are, who they work best for, and what to keep in mind if you’re considering a 5/1 ARM for your mortgage.
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What is a 5/1 ARM loan?
A 5/1 ARM is a kind of hybrid adjustable-rate mortgage, as it has both a fixed-rate and adjustable-rate portion. The fixed interest rate is for the first five years (that’s the “5” in “5/1”), known as the “teaser period” or “introductory period.” After that, the rate will be adjusted annually (that’s what “1” stands for).
During those first 60 months, borrowers enjoy predictable payments that stay the same throughout the intro period and are usually lower than those of fixed-rate loans. Once the adjusted period begins, the rate (and the associated monthly payment) may change every year depending on the chosen market index.
How does a 5/1 ARM work?
Here’s a more detailed overview of what to expect when getting a 5/1 ARM loan:
- Initial fixed-rate period: For the first five years, your interest rate remains unchanged, providing predictable monthly payments and a lower “teaser rate” compared to standard fixed-rate loans.
- Adjustment period: After the fifth year, the interest rate resets annually. The lender will add a margin to their chosen financial index (usually SOFR or COFI), and that’s how the new rate for the year will be determined. While the index rate is variable, the added margin doesn’t change over the loan’s entire term.
- Rate caps: 5/1 ARMs have limits on how much the rate can both decrease and increase at the first adjustment (typically 2% or 5%), per adjustment, and over the loan’s lifetime (commonly 5-6% above the initial rate).
Who should consider a 5/1 ARM?
Many borrowers use 5/1 ARM loans to take advantage of the lower initial payment when they don’t plan to keep the loan for the full term:
- Homebuyers planning to move in the next five years
- Those who plan to refinance before the adjustable period begins
- Buyers who anticipate lower index rates in the future, when the adjustable period takes effect
- Those who expect income growth in upcoming years (for example, early-career professionals)
The biggest downside of ARMs is the uncertainty in the longer term. While you score a lower initial payment, your monthly payments can increase significantly if index rates go up.
Other ways to get a lower interest rate
If you’re looking into a 5/1 ARM specifically for its low initial interest rate, consider other strategies that can help you secure a lower mortgage rate:
- Buy mortgage points: This tactic could be suitable for those who plan to stay in the house for a longer term. You pay up front at closing, with one mortgage point typically costing 1% of the overall mortgage amount. In return, the lender will reduce the interest rate on the loan by a quarter percentage point (0.25%) for each point purchased.
- Shop around for a lender: Rates, fees, and terms can vary significantly between lenders. Compare at least a few options and don’t forget to negotiate with your chosen lender.
- Improve your financial profile: See if you can increase your credit score or lower your debt-to-income ratio before applying for a loan. A higher credit score combined with lower DTI can lead to significantly lower rates.
- Make a larger down payment: Putting more money down will reduce the loan-to-value ratio (LTV), which might positively impact the interest rate. What’s more, if you put down more than 20%, you can avoid paying private mortgage insurance (PMI), which helps lower your monthly payments.
5/1 ARM: pros and cons
If you’re considering whether a 5/1 ARM is right for you, ensure you understand its advantages and disadvantages.
✅ Pros
- Lower initial monthly payments and interest rates (during the teaser period)
- Potential savings if rates fall after the initial period
- Could be beneficial for homeowners who want to sell before the adjusted period begins
❌ Cons
- Higher uncertainty in the long term
- Over time, interest and payments could exceed those of a fixed-rate mortgage if the market situation is unfavorable
- Could be harder to qualify for
Generally, while 5/1 ARMs are often seen as riskier than conventional loans, they can make financial sense if used wisely. For example, if you have a solid exit strategy and understand that the payments can rise and have some flexibility in your budget, this option could be worth considering.
Note: It’s possible to refinance a 5/1 ARM to another ARM or a fixed-rate mortgage if you want more predictability in the future. Although it comes with additional closing costs that you can either pay upfront or fold into the loan, it’s a viable option used by some homeowners.
5/1 ARM example
Now, let’s look at a simplified example of a 5/1 ARM for a $500,000 home and how payments can change after the fixed teaser period.
Let’s assume the down payment is 20%, which makes the loan amount $400,000, and the interest rate is 5.00% during the fixed-rate period. After the introductory rate comes to an end, the interest rate increases by 0.5% annually.
| Years | Interest rate | Monthly payment |
|---|---|---|
| 1-5 | 5.00% | $2,147 |
| 6 | 5.50% | $2,269 |
| 7 | 6.00% | $2,393 |
| 8 | 6.50% | $2,515 |
As you can see, after the fixed-rate period ended, the interest rate increased significantly, and the monthly payments rose by more than $350 — all of this in three years. While our scenario is fictional, a similar increase could certainly happen in real life.
5/1 ARM vs. 7/1 ARM vs. 10/1 ARM: Quick comparison
Wonder which of the common types of adjustable-rate mortgages is right for you? While a 5/1 ARM is likely to come with the lowest initial rates, a 10/1 ARM offers more stability for the entire decade of the loan's introductory period.
| Loan type | Fixed-rate period | Characteristics | Best for |
|---|---|---|---|
| 5/1 ARM | 5 years | Lowest initial rateMost uncertainty after 5 years | Short-term owners |
| 7/1 ARM | 7 years | Two extra years at a fixed rateSlightly higher initial rate | Medium-term owners |
| 10/1 ARM | 10 years | Stability for 10 yearsHighest initial rates | Long-term owners |
If you’re trying to decide between these options, think about the following:
- Estimate how long you’re planning to live in the property.
- Review rate caps to understand the maximum annual and lifetime increases you could face.
- Consider your risk tolerance and the importance of immediate savings.
5/1 ARM loans: Save money upfront but be prepared to pay more later
A 5/1 ARM loan can help buyers save money up front and may be a suitable option for those who expect their income to grow or intend to sell their property in the short term. However, this loan requires proactive planning and risk management for when the rate adjusts.
Make sure to consult a financial advisor and compare a few options if you are unsure which loan would be best for your situation. And, for any real estate-related questions, you can connect with top real estate agents in your area through Clever.