Rates on 30- and 15-year mortgages are super low in 2013, but if you want the best mortgage rate for your home purchase or refinance, you’ll probably need to explore hybrid adjustable rate home loans. Hybrid ARMs come with a variety of terms like 10/1, 7/1, 5/1 and 3/1 ARMs. The most popular of these home loans is the 5/1 ARM.
What Is It?
The 5/1 ARM is called a hybrid mortgage because it combines characteristics of a 30-year fixedrate loan with those of an adjustable rate mortgage. Hybrid ARMs are almost always amortized (repaid) over a 30-year term. The first number in the name of a hybrid mortgage represents the number of years the initial rate is fixed, and the second number indicates how often the loan may adjust once that fixed period ends. A 3/3 ARM means the rate is fixed for three years and then adjusts every three years thereafter. A 5/1 ARM has a fixed rate for five years and then adjusts annually.
What’s Great About It?
The interest rate on a 5/1 ARM runs about one percent lower than that of a comparable 30-year fixed mortgage. The loan gives lenders more protection from inflation than they get from a fixed mortgage, so they are willing to charge borrowers a lower rate. For people who don’t plan to keep their mortgage for more than a few years, the 5/1 provides substantial savings.
If you aren’t in a lifelong relationship with your home, the 5/1 ARM could be your most sensible choice. If you’re offered a 30-year loan at four percent and a 5/1 at three percent, how much less would you pay over five years if you borrow $250,000?
|30 Year Fixed||5/1 ARM||Difference|
|Over 5 Years:||$71,640||$63,240||$8,400|
|Balance after 5 Years:||$226,119||$222,266||$3,853|
In five years (60 payments), you’d pay $8,400 less and reduce your principal by $3,853 more for a total savings of $12,253.
What’s Not Great About It?
Life doesn’t always go as planned. Understand that there is some risk of being stuck in your home when your mortgage adjusts, and be prepared to make a higher payment if you must. It’s important that you know exactly how high your rate could adjust in five years. In the above example, for example, if the rate increased from three percent to five percent on year six, the payment would jump to $1,299 per month.
Who Is it For?
The 5/1 hybrid ARM is a great loan for those who don’t plan to keep their home or their mortgage for more than a few years. It allows borrowers to have a lower rate which is fixed for all or most of the time in which they plan to own their home. In addition, many folks with jumbo mortgages opt for hybrid ARMs because the difference between the 30-year jumbo mortgage rate and the jumbo hybrid ARM rate can be even greater than it is for smaller mortgages.
How Do You Get One?
The 5/1 is widely available and comes in conforming and jumbo loan amounts, conventional (non-government), FHA and VA options. It is considered a slightly riskier mortgage than the fixed rate loan, so qualifying can be tougher – you might need a higher credit score, a bigger down payment and / or higher income to get approved for a 5/1 loan.
Choosing a 5/1 ARM is one way to get a lower mortgage rate. Getting several quotes from competing lenderswhen you shop for that mortgage can save you even more.