Want the lower initial interest rate of an adjustable-rate mortgage (ARM) with at least some of the stability of a fixed-rate loan? The 5/5 ARM might be an option.
This relatively new loan is popular among consumers who want low monthly payments but don't want to worry each year that this payment might rise. That's because the interest rate attached to a 5/5 ARM doesn't reset — or adjust — as often as it does with a traditional loan.
Is it Right for You?
That doesn't mean that the 5/5 ARM is the right mortgage choice for all borrowers. Even though there is less financial risk than with traditional ARMs, there is still some.
"As with all ARMs, you are taking a little bit of a gamble," said John Walsh, Chief Executive Officer of Milford, Connecticut-based Total Mortgage. "If after you set your interest rate for five years interest rates start decreasing, then you made the wrong decision. If rates start increasing after you set your initial rate, then you made the right decision for those five years."
Traditional ARMs are attractive because they come with lower initial interest rates. But they also come with higher risk: After a set number of years — often five or seven years, but perhaps as many as 10 — in which the interest rate with an ARM remains unchanged, it then adjusts every year, rising or falling according to which economic indices the ARM is attached to.
An ARM might be tied to the London Interbank Offered Rate, better known by the acronym LIBOR. After an ARM's fixed-rate period ends, each year that loan's interest rate will rise or fall depending on what's happening with the LIBOR index.
There is a bit of a safety net built into most ARMs. They'll usually come with a cap that limits how much monthly payments can rise once the loan enters its adjustable period. An ARM might have a cap of 2% plus the one-year Libor index, for example.
That's complicated, so it's important to ask your lender just how big of a jump your mortgage payment can take during its adjustable years. If you can't handle the maximum possible increase? An ARM might not be for you.