5/1 ARM loan: How it works, pros and cons

If you’re planning to sell your home within the next few years, a 5/1 adjustable-rate mortgage (ARM) could help you maximize savings on interest costs during your time as a homeowner. Unlike fixed-rate mortgages that lock in one rate for the life of the loan, a 5/1 ARM offers a lower initial rate for the first five years before adjusting to market conditions. For short-term homeowners, this strategy can translate to meaningful savings upfront. Let's explore how 5/1 ARMs work and whether this mortgage option aligns with your timeline and financial goals.

Key takeaways:

• A 5/1 adjustable-rate mortgage (ARM) is a hybrid mortgage that offers a fixed, lower interest rate for the first 5 years of the loan, after which the interest rate adjusts once a year based on market conditions.
• The "5" represents the initial 5-year fixed-rate period, while the "1" represents the 1-year adjustment interval during the variable phase.
• A 5/1 ARM is best suited for homebuyers who plan to sell the property or refinance into a fixed-rate mortgage within 5 years, as well as early-career professionals expecting significant income growth before the variable phase begins.

What is a 5/1 ARM loan?

An adjustable-rate mortgage is a 30-year mortgage with an interest rate that is set for an initial period and then changes on a regular basis after that. The first number that appears before an ARM is the number of years that the loan is fixed, and the second number is the interval in years or months between rate adjustments. In the case of a 5/1 ARM, the rate is set for the first five years, then adjusts once per year after that. That means your principal and interest payment won’t change for the first five years.

Interest rates for ARMs are initially lower than interest rates for fixed-rate loans, which is an important difference between an ARM vs. a fixed-rate mortgage. That can make them more affordable during the initial rate lock. After the rate lock ends, the rate and monthly payment can rise or fall, so you need to plan when choosing an ARM.

What the 5 means

The number "5" indicates the length of your initial fixed-rate period. For the first 5 years after closing on your home, your interest rate remains locked and cannot change regardless of what happens to national interest rates. That will keep your first 60 monthly payments stable.

What the 1 means

The number "1" represents the adjustment interval after the initial fixed period expires. Beginning in year 6, your interest rate will adjust once per year for the remaining 25 years of the 30-year loan term.

How does a 5/1 ARM work?

A 5/1 ARM operates in two distinct phases over a standard 30-year loan lifespan.

Initial phase

During years 1 through 5, your mortgage operates just like a traditional fixed-rate loan. During this time, your interest rate won’t change, giving you predictable monthly payments. The introductory rate is also typically lower than the rate on a standard 30-year fixed-rate mortgage, which means your payments will also be lower during your first 5 years of homeownership.

Adjustment phase

Starting at the beginning of the sixth year (the 61st monthly payment), the initial rate lock expires. Your lender recalculates your interest rate once every 12 months by adding a predetermined lender margin to a benchmark financial index, such as the Secured Overnight Financing Rate (SOFR). If market rates rise, your monthly payment increases, and if market rates fall, your payment drops.

Key 5/1 ARM terms to know

If you’re considering a 5/1 ARM, it’s important to understand the different terms and concepts that apply.

Interest rate changes

Once the initial interest rate period ends, your loan’s interest rate will start to change. Depending on the terms of your loan and the interest rate market, the rate could rise or fall. That means your monthly payment could go up or down. If it rises, your mortgage payment will increase, and your loan can become harder to afford.

Adjustment intervals

The adjustment interval of an ARM is how frequently the loan’s rate can change. In the case of a 5/1 ARM, it changes after the initial five years elapse and goes on to change one time per year for as long as you have the loan.

At each adjustment interval, the rate could rise or fall depending on the rate cap and rate floor as well as the market rate. You should check your loan’s paperwork to understand how or if the rate can rise or fall, so you can prepare for potentially varying mortgage payments.

Index and margin

Most ARMs use an index rate and a margin to determine the new rate at each adjustment. For example, the rate may be the constant maturity rate + 2% or the secured overnight funding rate + 2.5%. In some cases, the amount your rate can rise or fall in one adjustment, as well as how far it can rise or fall in total, will be limited by a rate cap or floor.

Index rate + Lender Margin = Fully Indexed Rate

Rate caps

Many ARMs come with rate caps that place limits on how much your loan’s rate can change at one time. They also limit how high or low the rate can be.

For example, a 5/1 ARM with a 2/2/5 cap structure has a rate that can change no more than 2% at the initial and each subsequent adjustment period, with a maximum increase of 5% over the initial rate.

• Initial adjustment cap: This limits the amount the rate can adjust upward the first time the payment adjusts. In this example, regardless of market conditions, the first adjustment can’t exceed 2%.
• Periodic adjustment cap: Based on our example, with each adjustment after the first one, the rate can’t go up by more than 2%.
• Lifetime cap: The final number is the lifetime limit on increases. Regardless of market conditions, the mortgage’s interest rate can’t go up by more than 5% for as long as you have the loan.

Your loan’s estimate and closing disclosure should outline any rate caps that apply to your loan.

Interest rate floors

Like an interest rate cap, an interest rate floor sets a limit on how much your loan’s interest rate can change. In this case, it restricts how far the rate can fall rather than how high it can rise.

For example, if you have an ARM with a rate of 6% and a floor of 5%, even if the market rates would dictate that your loan’s rate should adjust to 4.5%, it will fall only to 5%.

5/1 ARM loan example

Let’s compare a 30-year fixed-rate mortgage for $250,000 with a 7.5% interest rate against a 5/1 ARM for the same amount with 2/2/5 caps and an initial interest rate of 7%. For this example, these monthly payments do not include extra payments, taxes, or insurance.

When an ARM resets, the interest part of the payment is calculated based on the new lower principal that remains after the fixed-rate period. But the amount of the payment will go up or down based on a combination of factors, including the new interest rate.

In our example with a fixed-rate mortgage, you’re looking at a monthly payment of $1,748, not including taxes and insurance. The ARM loan has an initial payment of $1,663, saving you $85 per month for the first 5 years of the loan.

After five years, the ARM’s rate changes while the fixed-rate mortgage stays the same.

If your ARM interest rate goes up by the maximum amount allowed under the cap, your new payment would be $1,975, close to $300 a month more than the fixed-rate loan. In the seventh year, if interest rates were higher and went up by the maximum amount, the new payment at an 11% interest rate would be $2,299.

This illustration shows the importance of preparing for rising payments.

How to compare 5/1 ARM loans

When you compare ARM offers to figure out the best possible terms, pay attention to the following components:

• Loan caps: Always request the exact cap structure so you know if it’s a 2/2/5 ARM or a 5/2/5 ARM. Lower initial and lifetime caps reduce your maximum potential monthly exposure during the variable phase.
• Compare index and margin: Check which market index the lender uses and compare the margin added. A loan with a 2.25% margin will cost less during the variable phase than a loan with a 3.00% margin on the same index.
• Use a loan calculator: Run best-case and worst-case adjustment calculations using an online home affordability calculator to ensure you can afford payments if the loan reaches its lifetime rate cap.
• Check current rate information: Compare the initial ARM discount against current 30-year fixed rates. If the introductory ARM rate is only slightly lower than a fixed rate, taking on future adjustment risk may not offer sufficient savings.

Pros of a 5/1 ARM

There can be many benefits to getting a 5/1 ARM, including:

• Lower initial rate than for fixed-rate mortgages. Introductory interest rates for an ARM are generally lower than with a fixed-rate mortgage.
• Caps on future rate hikes. There are some limits on how high your mortgage rate and payment can rise.
• Flexibility for short-term owners. If you refinance or sell before the initial rate period ends, you can save money overall on the loan.
• Opportunity for lower payments: If benchmark market interest rates decline after year 5, your rate and monthly payment will decrease automatically without requiring a refinance.

Cons of a 5/1 ARM

5/1 ARMs, and other types of ARMs like 7/6 ARMs, aren’t right for everyone, so keep these drawbacks in mind:

• Potentially higher payments after the initial term. If rates rise, your monthly payment will increase too.
• Potentially higher interest cost. If rates rise, you could pay more in interest overall than with a fixed-rate loan.
• More complexity. ARMs may have more conditions, fees, and jargon involved than fixed-rate loans, so it can be harder to understand how they work or compare them to other loans. Be sure to ask your lender or a mortgage professional about any terms you don’t understand.
• Less predictability. Unpredictable payments mean you need to be prepared for the unexpected and able to handle possible increases in your payments.
• Less ideal for long-term owners. The unpredictability of your loan costs in the long run makes ARMs a worse choice for people buying their forever homes as opposed to a starter home. If you end up staying in your home and need to refinance¹ to get a better mortgage term¹, you’ll have to pay closing costs again, which are usually 3% - 6% of the loan amount.

5/1 ARM loan requirements

The qualification requirements for a 5/1 ARM are like the eligibility criteria for fixed-rate conventional loans. Note that exact requirements vary depending on the lender.

Credit and financial factors

Lenders review your credit score, debt-to-income (DTI) ratio, and income documentation. You’ll typically need a credit score of at least 620 and a DTI that doesn’t exceed 43%.

To make sure borrowers can afford their ARM, mortgage underwriters will likely evaluate your DTI ratio using the maximum possible payment allowed under the year 6 initial rate cap rather than just the initial discounted rate.

Down payment considerations

Conforming 5/1 ARMs generally require a minimum down payment of at least 5%. Putting down less than 20% on a conventional ARM will require paying private mortgage insurance (PMI) until you reach 20% equity.

Is a 5/1 ARM loan right for you?

Evaluating your income, budget, and timeline can help you decide if an ARM is the right fit for your home purchase.

You can use Rocket Mortgage’s loan calculator to get a better idea of the cost of different loans to help you decide if a 5/1 ARM is worth it.

When a 5/1 ARM may make sense

A 5/1 ARM might be right for you if:

• You plan to move within 5 years: If you are buying a starter home or a property you plan to sell within 5 years, you get to benefit from upfront savings without facing rate adjustments.
• You plan to refinance early: If you intend to refinance into a fixed-rate mortgage before month 60, initial rate savings can be helpful.
• Your income will rise significantly: Early-career professionals - such as medical residents - who expect substantial salary growth before year 6 may be confident they can higher future payments.

When a 5/1 ARM may not make sense

Here are some circumstances where you may be better off with a fixed-rate mortgage.

• Rates are on the rise: If it’s looking like market rates are likely to increase, you’ll want to lock in a lower rate now.
• You can’t afford higher payments: If your household budget cannot absorb potential payment increases of several hundred dollars per month in the sixth year, the risk of an ARM outweighs the initial savings.
• You’ve found your forever home: If you plan to remain in the residence long-term, a fixed-rate mortgage provides 30 years of payment stability.

Alternatives to a 5/1 ARM loan

If a 5/1 ARM seems too risky for you, know that you have other mortgage options.

Fixed-rate mortgage

A traditional fixed-rate mortgage locks your interest rate and monthly principal and interest payment for the entire 15- or 30-year loan term, eliminating market volatility risk.

Other ARM terms

If you want introductory rate savings with a longer fixed window, explore longer hybrid ARMs:

• 7/1 or 7/6 ARM: Offers a fixed interest rate for the first 7 years before adjusting annually or semi-annually.
• 10/1 or 10/6 ARM: Provides a fixed rate for a full 10 years before entering the adjustable phase.

FAQ

Before applying for an ARM, make sure you understand how they work.

How do I qualify for a 5/1 ARM?

Qualifying for an ARM is like qualifying for any other loan. Once you apply, the lender will check your credit, debt-to-income ratio, and other financial factors.

Where can I find current 5/1 ARM rates?

Interest rates fluctuate daily based on economic conditions. To view real-time rate comparisons, visit the Rocket Mortgage rates page.

Can you refinance out of a 5/1 ARM?

Yes. You can refinance an ARM loan into a fixed-rate mortgage before or during the adjustment phase if you qualify for the new loan.

What is the difference between a 5/1 ARM and a 7/1 ARM?

A 5/1 ARM keeps your interest rate fixed for the first 5 years, whereas a 7/1 ARM keeps your rate fixed for the first 7 years. Both loans adjust annually after their respective fixed periods expire.

Is a 5/1 ARM a 30-year mortgage?

Yes. A standard 5/1 ARM is a 30-year mortgage consisting of a 5-year fixed-rate phase followed by a 25-year adjustable-rate phase.

Why are 5/1 ARMs referred to as hybrids?

They’re referred to as hybrids because they behave like fixed-rate mortgages during the introductory period. For 5 years, home buyers who choose an ARM enjoy fixed payments, generally at a lower interest rate than buyers with a fixed-rate mortgage. It’s only after the introductory period ends that ARMs may become more expensive and unpredictable, depending on what is happening with interest rates in the macroeconomic environment.

What is a convertible 5/1 ARM?

Homeowners with a convertible 5/1 ARM have the option of converting their ARM into a fixed-rate mortgage at a time designated in the mortgage contract. Homeowners enjoy a low introductory rate as well as the peace of mind that comes with having a fixed-rate option. Keep in mind that Rocket Mortgage does not currently offer convertible ARMs.

What is a 5/1 interest-only ARM?

An interest-only loan is a type of nonconforming mortgage that charges only interest for a set introductory period. For example, if you choose a 5/1 interest-only ARM, you’ll make interest payments only for the first 5 years. Thereafter, your mortgage would start amortizing, meaning you would begin paying principal and interest as part of your monthly mortgage payment.

Rocket Mortgage does not currently offer interest-only loans.

What do I do if interest rates increase dramatically?

If interest rates rise by a large amount, one option is to plan for making payments based on your mortgage interest rate cap. Another option is to consider refinancing to a new fixed-rate loan if you think rates might rise further and you want to lock in a rate you can handle.

The bottom line: A 5/1 ARM can save you money under the right circumstances

ARMs let you trade predictability for affordability. For the first five years, a 5/1 ARM will typically have a lower interest rate and payment than a fixed-rate loan. However, after five years, the rate can adjust, potentially rising and making your mortgage payment more expensive. For people who only plan to keep a home for a few years, an ARM can be a good way to save money.

Before applying for any type of loan, make sure you consider all your options and work with a lender to ensure you understand the ins and outs of how the loan will work. Once you feel ready, you can start an application with Rocket Mortgage.

¹Refinancing may increase finance charges over the life of the loan.

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Any figures, interest rates, loan examples, and market data referenced in this article are hypothetical or aggregated for educational purposes only. They are not intended to reflect current pricing, available terms, or personalized loan options for any consumer. This content does not constitute an advertisement of credit terms, a solicitation or offer to extend credit, or a rate quote under federal or state lending laws. Actual mortgage rates and terms are determined by individual financial qualifications, property characteristics, market conditions, and other factors, and are subject to change without notice.

If you are seeking current, real-time mortgage rate information please refer to the official live rate information and product details published on the Rocket Mortgage rates page where current pricing and various loan terms are made available.