When it comes to choosing a mortgage, home buyers have a variety of options. One popular choice is a 5-year adjustable-rate mortgage (ARM). This type of mortgage offers a fixed interest rate for the first five years, followed by an adjustable rate for the remaining term. While some may be hesitant about the potential for rate increases, a 5-year ARM actually has several benefits that make it a smart choice for certain homeowners. In this article, we will explore the advantages of a 5-year ARM, including lower initial interest rates, the potential to pay less overall interest, and its suitability for short-term homeowners.
Lower Initial Interest Rate
One of the primary benefits of a 5-year ARM is the lower initial interest rate it offers compared to a fixed-rate mortgage. During the first five years of the loan, borrowers can enjoy a lower interest rate, which translates to a lower monthly payment. This can provide homeowners with financial flexibility, allowing them to allocate the saved funds towards other expenses, investments, or even paying down the principal of the loan.
Unlike fixed-rate mortgages, where the interest rate remains constant throughout the loan term, an ARM’s interest rate is subject to change. However, the initial rate of a 5-year ARM is typically significantly lower than prevailing rates on fixed-rate mortgages. This introductory rate is sometimes referred to as a “teaser” rate, as it entices borrowers with its affordability.
Potential to Pay Less Overall Interest
Another advantage of a 5-year ARM is the potential to pay less overall interest over the life of the loan. When homeowners opt for an ARM, they can take advantage of the lower initial interest rate and utilize the savings to make additional payments towards the principal balance. By reducing the principal balance, borrowers can minimize the amount of interest they pay, even if the interest rate adjusts upward in the future.
To illustrate this, let’s consider a scenario where a borrower saves $70.93 per month by choosing a 5-year ARM instead of a fixed-rate mortgage. If they allocate this monthly savings towards the principal, they would reduce the balance by $4,255.80 over the first five years. As a result, when the interest rate resets at a higher rate, their monthly payment would be lower than it would have been without the additional principal payments. This not only saves money in the short term but also leads to significant interest savings over the lifetime of the loan.
Suitability for Short-Term Homeowners
A 5-year ARM can be an excellent choice for homeowners who know they will be moving or selling their home within a few years. Since the initial fixed-rate period of the mortgage is five years, those planning to relocate before the adjustable-rate period begins can avoid any potential rate increases altogether.
This advantage is particularly beneficial for individuals who are in a starter home or anticipate a change in their living situation due to career advancements or personal circumstances. By opting for a 5-year ARM, homeowners can enjoy the benefits of a lower initial interest rate without worrying about the long-term implications of rate adjustments.
Considerations for Adjustable-Rate Mortgages
While a 5-year ARM offers several advantages, it’s essential to consider the potential disadvantages and evaluate whether this type of mortgage aligns with your financial goals and circumstances. Here are a few factors to keep in mind:
Relatively Short Introductory Period
Compared to other types of ARMs, a 5-year ARM has a relatively short introductory period. This means that homeowners must make decisions about their mortgage strategy within the first five years. If you plan to stay in your home beyond this period, you will need to consider whether refinancing, selling, or transitioning to a fixed-rate mortgage is the best course of action.
The adjustable period of a 5-year ARM is much longer than the fixed-rate period. This introduces a level of uncertainty as the interest rate can fluctuate based on market conditions. While you may feel confident in your ability to handle larger mortgage payments due to career advancements or increased income, it is essential to assess your risk tolerance and financial stability before committing to a 5-year ARM.
Costly to Refinance
For buyers who do not plan to stay in their homes for an extended period, a 5-year ARM can be an attractive option. However, it’s crucial to recognize that if you need to refinance after the initial five years to afford the higher payments, you will incur closing costs. Refinance closing costs can range from 2% to 5% of the loan balance, so it’s essential to factor these expenses into your long-term financial planning.
A 5-year adjustable-rate mortgage can be a smart choice for certain home buyers. The lower initial interest rate allows for more affordable monthly payments, providing financial flexibility and the potential to pay less overall interest. Additionally, the suitability of a 5-year ARM for short-term homeowners makes it an attractive option for those who anticipate selling or moving within the first five years of home ownership.
However, it’s important to consider the relatively short introductory period, the uncertainty of rate adjustments, and the potential costs of refinancing before committing to a 5-year ARM. By thoroughly evaluating your financial goals, risk tolerance, and future plans, you can determine whether a 5-year ARM aligns with your needs and preferences.
Dan provides clients with years of proven experience and an abundance of financing options for their mortgages. His common sense approach and devotion to customer service is what sets him apart in the highly competitive mortgage industry. Dan prides himself on consistently delivering “referable services” to his clients, referral sources, and partners.