Mortgage rates welcomed 2017 with a bang or a breather for homebuyers and refinancers. As of January 5, 2017, mortgage rates on 30-year FRMs slowed down to 4.20% while 5/1 ARMs moved slightly to 3.33%. With almost a percentage-point difference, a 5/1 ARM is still lower compared to a 30-year FRM. Is it worthwhile to refinance into a 5/1 ARM?
Adjusting Into 5/1 ARMs
Five/one (5/1) ARMs are basically 30-year mortgages with rates that adjust after five years. Known as 5-1 hybrid ARMs, they contain elements from fixed-year mortgages and adjustable-rate mortgages, as we shall examine here:
- The “5” in the 5/1 refers to the five years where the interest rate is fixed.
- The “1” in the 5/1 refers to the annual adjustment of the rate after the fixed five-year period.
Once the fixed period lapses, the interest rate will then adjust once a year for the remaining 25 years of the loan. As to how this fully indexed rate will adjust, i.e. will it go up or down year after year, is based on the index plus the margin.
The index changes based on the market index it is tied to while the margin is constant throughout the loan term. This mechanism (index plus margin) keeps in check or limits the rate increase, as applicable.
Using the 5/1 ARM’s average rate of 3.33% per the Freddie Mac weekly survey, your monthly mortgage payment will be fixed and will remain that way until the initial rate resets after five years.
Best of Both Worlds
Refinancing into a 5/1 hybrid ARM presents the best of both worlds to borrowers, wrapping the benefits of two types of mortgages into one loan.
Stability. Five/one hybrid mortgages offer rates lower than their fixed-rate counterparts. And these low rates remain fixed for five years. This gives you the security of making lower loan payments during the period at fixed rates.
Short-time. These mortgages target borrowers who plan to stay in the home within the introductory period of five years. When the rate reset comes, you can refinance into another loan to avert any rate hike or pay off the loan within the five years, if applicable.
Surprise. Depending on market forces and headwinds, the rate following the initial period would come as a surprise or a shock for borrowers. If the rate increases, it sends your monthly payment to go up. But if it does decrease, it could further lower the monthly amortization payment.
Refinancing Into a 5/1 ARM
The rate adjustment, especially a rate hike, makes homeowners wary of hybrid ARMs. Thus to help you decide whether a five-year ARM is a good replacement to your old mortgage, consider these:
- Is five years enough a period to finish off your mortgage?
- Can you handle any changes in your mortgage payment if it increases and you don’t refinance?
- Do you plan to stay within or beyond five years?
Essentially, refinance into a 5/1 hybrid ARM if you want to take advantage of lower rates and plan to move out of the property in time or before the rate resets. If you are willing to take the risk of a higher/lower rate later with the opportunity to refinance at a fixed lower rate now, then a 5/1 ARM may be for you.
Justin McHood is a managing partner at Suited Connector and has been recognized by national media outlets as a financial expert for more than a decade.
