Is a 5/5 Adjustable Rate Mortgage (5/5 ARM) Right for You?

An Adjustable Rate Mortgage (ARM) is not for everyone, but everyone should know about them.  If you know for certain you will be moving in the next 5-10 years, an ARM may be the better choice.  A 5/5 ARM just might be the perfect loan for some in 2018.  A mortgage with a lower rate can save you money.  People move for various reasons, life happens.  You may move for employment, family or housing needs.  According to the Census Bureau1, people move on average of 11.7 times within their lifetime.

How mortgage reform created a better ARM

In 2010, President Barack Obama signed into Federal law The Dodd-Frank Wall Street Reform and Consumer Protection Act2 (a copy may be found here).  The act eliminated risky features like pre-payment penalties and negative amortization.  Most ARMs today use a more stable index.  For example, a 5/1 ARM uses the 1-year Libor while a 5/5 ARM uses the 5-year CMT.  To find your interest rate, add the index + margin.  

Is a 5/5 ARM, a balance of stability and lower rate?

A 5/5 ARM might be the better choice for some.  The low initial rate stays fixed for 5 years.  After 5 years, it adjusts once and is fixed for another 5 years.   That’s two adjustments in 15 years.  A traditional 5/1 ARM is fixed for 5 years and then adjusts every year thereafter.  The rate can adjust by a maximum of 2% every five years.  The cap or the limit of the interest rate change is 5% from your initial rate.  If rates come down, your rate will as well.

Choosing the right tool for the job:

Interest rates as of 2/21/2018.  This is some sample purchase loan rates for a purchase price of $500,000 and a loan amount of $300,000.

How much can you expect to save compared to a 30-Year Fixed?

Other considerations

According to the Urban Institute, only 2.1% of people obtained an ARM in 20163.  Close to 98% of consumers obtained a fixed rate.  In a low rate environment, an adjustable rate mortgage usually does not make sense.  If rates go up more, the spread will increase and Arms may be more attractive.  A 5/5 Arm is priced close to a 5/1 Arm and gives you more stability because the adjustment periods is every 5 years, not every year.

  1. For example, you plan on moving or refinancing in the next 5-10 years.
  2. You expect your household income to increase in the next few years.

Life is unpredictable.  While we always hope for the best, we should still plan for the worst.  You may want to speak to a financial advisor to come up with your worst-case numbers.  Basically, you will want to know the minimum income needed to cover your expenses if something were to happen.

Conclusion

An ARM may be a solid choice if you are planning on moving in the next 5-10 years.  Some of the pluses are a lower monthly payment or attacking your principal balance.  If you are considering an ARM, take a look at the 5/5 Arm.  It adjusts only once every 5 years.  In 15 years, there are only two adjustments.

Our goal at Candor Mortgage is to support you with solid advice.  We are here to give you the information you need to make the right decision for you.  If you’re interested in learning more or discussing your unique situation, call us at (800) 714-3184.


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Sources:

  1. https://www.census.gov/prod/2014pubs/p20-574.pdf?cssp=SERP.
  2. http://www.cftc.gov/idc/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf
  3. Housing Finance at a Glance.  The Urban Institute.  March 2017, Page 9.  A Monthly Chartbook.  https://www.urban.org/research/publication/housing-finance-glance-monthly-chartbook-march-2017/view/full_report.

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