What is the '5-1 Hybrid Adjustable-Rate Mortgage - 5-1 Hybrid ARM'
The 5-1 hybrid adjustable-rate mortgage (5-1 hybrid ARM) is an adjustable-rate mortgage (ARM) with an initial five-year fixed-interest rate, followed by a rate that adjusts on an annual basis. The "5" refers to the number of years with a fixed rate, while the "1" refers to how often the rate adjusts after that. Also known as a five-year fixed period ARM, this mortgage features an interest rate that adjusts according to an index plus a margin.
BREAKING DOWN '5-1 Hybrid Adjustable-Rate Mortgage - 5-1 Hybrid ARM'The 5-1 hybrid ARM is the most popular type of ARM, but it is not the only option. There are also 3/1, 7/1 and 10/1 ARMs. Respectively, these loans offer an introductory fixed rate for three, seven or 10 years, after which they adjust annually. In rare cases, there are also 5/5 and 5/6 ARMS, which both feature a five-year introductory period, followed by a rate adjustment every five years or every six months. There are also 15/15 ARMs that adjust once after 15 years.
How Do 5-1 Hybrid ARMS Adjust?
When ARMs adjust, their interest rates change based on their marginal rates and the indexes to which they are tied. For example, if a 5-1 hybrid ARM has a 3% margin and the index is 3%, it adjusts to 6%. However, the extent to which the fully indexed interest rate on a 5-1 hybrid ARM can adjust is often limited by an interest rate cap structure. There are several different indexes to which the fully indexed interest rate may be tied, and while this number varies, the margin is fixed for the life of the loan.
Advantages of a 5-1 Hybrid ARM
In most cases, ARMs offer lower introductory rates than mortgages with fixed interest rates. As a result, home buyers face lower payments during the introductory periods of their loans. Compared to fixed-rate mortgages, these loans are ideal for buyers who plan to only live in the home a short time and sell it before the end of the introductory period, or for buyers who plan to refinance before the introductory rate expires. In addition, when the rate adjusts, there is a chance that it may decrease, lowering the borrower's monthly payments.
Disadvantages of a 5-1 Hybrid ARM
In many cases, when the rate adjusts on these mortgages, it goes up, increasing the borrower's monthly payments. Additionally, if a borrower takes out an ARM with the intent of getting out of the mortgage through selling or refinancing before the rate resets, personal finances or market forces may trap him in the loan, potentially subjecting him to a rate hike he cannot afford.