What You Need to Know About 5/1 ARM Refinance Loans

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When you get a 5/1 ARM refinance, you get a fixed interest rate for five years, which adjusts every year after that period is over. (Shutterstock)

Mortgage refinance options can be confusing, especially when comparing fixed-rate and adjustable-rate loans. Although you can think of a mortgage refinance as a fixed rate loan, it is possible to refinance a fixed or adjustable rate mortgage into a new ARM.

A 5/1 ARM refinance may make sense for you, depending on your personal circumstances. Here’s what you need to know about 5/1 ARM refinance loans.

If you’re considering refinancing your mortgage, it’s a good idea to compare rates from several lenders. With Credible, you can see custom pricing in minutes.

What is an ARM 5/1 refinance loan?

A 5/1 ARM is a type of variable rate mortgage that is a hybrid of a fixed rate loan and a variable rate loan. The first number represents the number of years your loan has a fixed rate. The second number indicates how often your rate can adjust after the fixed rate period ends. For an ARM 5/1, it’s once a year.

It’s common to see ARM loans labeled 3/1, 5/1, 7/1, and 10/1, although 5/1 is the most popular.

A 5/1 ARM refinance is a variable rate loan you can take out to pay off and replace your current mortgage. You can choose to refinance with an ARM whether your original mortgage was a fixed rate loan or another ARM.

How does an ARM 5/1 refinance loan work?

A 5/1 ARM refinance loan works the same way as an ARM you take out to buy a house. At the end of the initial five-year fixed rate term, the interest rate on your loan will reset. After that, your interest rate – and your monthly payments – can change once a year based on an index used by the lender.

If interest rates go up, you’ll end up with a higher monthly payment. If interest rates drop, you could pay less although that’s probably not a big drop.

To understand how an ARM 5/1 refinance loan works, you need to know a few terms:

  • Initial interest rate — The initial interest rate is the temporary fixed rate you will pay for the first five years on your 5/1 ARM refinance loan. On a 10/1 ARM, you’ll see a temporary fixed rate for the first 10 years, and on a 3/1 ARM, for the first three years.
  • Adjustment period — The adjustment period indicates how often your rate could change after the end of your initial fixed rate period. With a 5/1 ARM, your interest rate could change each year for the remainder of the loan term.
  • Index – The index is linked to a reference rate and often fluctuates with the market. Common indices include one-year constant maturity Treasury securities and the London Interbank Offered Rate (LIBOR).
  • Margin – To set your interest rate, lenders use a spread. Lenders add a few percentage points to the indexing rate to determine the interest you’ll pay on your ARM. Margins generally do not vary over the life of your loan.

5/1 ARM Refinance Loans vs Fixed Rate Refinance Loans

The main difference between ARM refinance loans and fixed rate refinance loans is that with an ARM, your rate is only temporarily fixed. With a 5/1 ARM, your rate is fixed for the first five years. After that, your rate adjusts every year. In contrast, with a 30-year fixed rate refinance loan, your rate is fixed for the life of your loan and never fluctuates.

Is there a rate cap for ARM 5/1 refinance loans?

Most ARMs have rate caps that limit how much a rate changes after your temporary fixed rate period ends. A common capitalization structure is 2/2/5 capitalization.

  • the initial adjustment cap limits the amount your rate can increase the first time your rate adjusts. With the 2/2/5 cap, your initial cap is 2%, which means that your first rate adjustment cannot be more than 2% higher than your original interest rate.
  • Subsequent adjustment ceilings limit the increase in your interest rate for future adjustments. As with the initial adjustment caps, subsequent adjustment caps are 2% with the 2/2/5 structure.
  • Lifetime limits, usually required by law, stipulate how much a rate can adjust over the life of your loan. Your interest rate generally cannot exceed your initial rate by more than 5% (the “5” in 2/2/5).

Credible makes it easy to compare mortgage refinance rates from multiple lenders, without affecting your credit.

Should You Get a 5/1 ARM Refinance Loan?

In certain situations, it may make sense to refinance into an ARM rather than a fixed rate loan, including:

  • A lower monthly payment is your top priority.
  • You plan to move or change jobs within five years of refinancing your mortgage.
  • You will be able to finish paying off your refinanced mortgage before the rate resets.

A lower interest rate can also allow you to pay off your mortgage sooner and build up equity in your home faster. If you’re about to retire, you might consider refinancing your mortgage to lower your interest rate and save money each month.

But if you plan to stay in your home long-term, be aware that you won’t be able to pay off the loan until it resets, or if you’re not sure you can refinance again, a 5/1 ARM refinance may not be right for you. you.

5/1 Pros and Cons of ARM Refinance Loans

As with any refinance option, you should consider the pros and cons of a 5/1 ARM:

Benefits

  • Lower initial interest rate — For the first five years of your loan, you’ll get a lower interest rate and monthly payment than a 30-year fixed rate loan.
  • The interest rate could fall — After the temporary fixed rate period, your payment may decrease if rates drop.
  • Faster loan repayment — A lower rate allows you to apply monthly savings to capital and pay off your loan sooner.

The inconvenients

  • The interest rate could increase — After the initial fixed rate period of your 5/1 ARM, your interest rate may increase. This could cause ‘payment shock’, which means your monthly payment is suddenly much higher than expected.
  • Makes budgeting harder — Your monthly payments can fluctuate each year after the fixed rate period ends, which can make budgeting tricky.
  • May pay more in aggregate interest — If you plan to stay in your home for a long time, you could end up paying more interest after the fixed rate period on your 5/1 ARM refinance than you would on a long-term fixed rate mortgage.

What are the eligibility requirements for ARM 5/1 refinance loans?

The requirements for a 5/1 ARM refinance loan are much the same as for fixed rate loans. To get the lowest rate, you’ll likely need a minimum credit score of 620. But since an ARM has a lower monthly payment in the first five years, it may be easier to qualify depending on your credit.

Lenders look at your employment history, previous years’ taxes, and income. Many lenders want your monthly payment to be no more than 28% of your gross income. Since this is a refinance, you will also need sufficient capital accumulated in your home, ideally 20% minimum. If you have less equity than that, you will need to pay for private mortgage insurance (PMI) until you reach that point.

Credible makes it easy to compare mortgage refinance offers from multiple lenders.

5/1 ARM Refinance Loan FAQs

Read on for answers to some common questions about 5/1 ARM refinance loans.

What should you look for in a 5/1 ARM refinance loan?

As with any refinance loan, you’ll want to consider the interest rate, especially the rate you’ll pay in the first five years of your 5/1 ARM. Also review the rate caps and margins set by your lender. Some ARMs come with prepayment penalties and other fees when you refinance your loan. Fees vary, so consider how much you’ll end up paying up front or in your loan as closing costs.

What if your interest rate goes up?

You will receive notice from your lender prior to an interest rate increase on your 5/1 ARM. When you receive this notice, you can choose to refinance to another ARM or to a fixed rate mortgage. If you plan to stay in your home for many years, a fixed rate mortgage might be the best choice.

But if you plan to move during your ARM’s fixed-rate period, refinancing to another ARM may be preferable. Remember that your payment will likely change after the fixed rate period ends and that lenders charge closing costs when you refinance your mortgage, so consider your budget when making this decision.

What is an ARM 5/1 interest loan?

With an interest-only 5/1 ARM, none of the payments you make each month for a certain period go towards paying off the principal balance. The interest-only period varies, but can last from several months to several years. After this interest-only period, your mortgage will pay off and be paid off at the end of your term.

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