What Is a 5/5 ARM and Should I Get One?
A 5/5 adjustable-rate mortgage offers a low fixed-interest rate for the first few years of your loan term. It could temporarily save you money in the short term when compared to a 30-year fixed-rate loan, but it’s worth knowing the risks to avoid ending up with an unaffordable mortgage payment after the initial rate period expires.
What is a 5/5 ARM?
A 5/5 ARM is an adjustable-rate mortgage with an initial rate fixed for five years of a 30-year loan term. After five years, the mortgage rate is variable and can change every five years for the remaining term of the loan.
One of the unique features of the 5/5 ARM is the longer adjustment period after the first five-year period ends. Many lenders offer 5/1 ARMs, which adjust every year after the fixed-rate period ends. The 5/5 ARM gives you five years in between adjustments, which allows for more breathing room in your budget for monthly payment changes than an ARM that adjusts every year.
Here are the standard features of a 5/5 ARM:
- Rate adjustments. The rate adjustments on 5/5 ARMs are tied to a benchmark called an index, such as the 1-year Constant Maturity Treasury Index (CMT).
- Margin. The margin is a set number of percentage points added to the index to determine your rate after the fixed-rate period expires.
- Periodic adjustment caps. These caps will determine how much your rate adjusts every five years. For example, a 5/5% ARM with a start rate of 5% and a 2% adjustment cap means your rate won’t be higher than 7% after the first five-year mark.
- Lifetime rate adjustment maximum. Most ARMs feature a lifetime rate adjustment maximum of five percentage points, although the amount may vary depending on the ARM program you choose.
THINGS YOU SHOULD KNOW
Because ARMs are tied to an index that can rise and fall, there’s a chance your rate may drop after the first five-year period. If the index tied to your 5/5 ARM is lower when your rate adjusts, you could end up with a lower rate locked in for the next five years.
Comparing 5/5 ARM and 5/1 ARM loans
The 5/1 ARM is similar to the 5/5 ARM because it offers a fixed rate for the first five years. However, the second number in the ARM type tells you when your rate and payment could change after your fixed-rate timeline is up: The 5/1 ARM adjusts every year, while the 5/5 ARM adjusts every five years.
Both 5/5 ARMs and 5/1 ARMs have rate adjustment caps based on 30-year payoff schedules. To see the difference in how the principal and interest payments adjust, we’ll take a look at how the payments might change assuming a $300,000 loan amount and a cap of 2% for every rate adjustment.
| ARM program | Initial start rate | Years | Maximum rate increases | Years | Monthly payment (principal and interest) |
|---|---|---|---|---|---|
| 5/1 ARM | 5.56%* | 1-5: 6: 7: 8: | 5.56% 7.56% 9.56% 10.56% | 1-5: 6: 7: 8: | $1,714.68 $2,109.98 $2,535.71 $2,757.68 |
| 5/5 ARM | 4.375%** | 1-5: 6: 7: 8: | 4.375% 6.375%% 6.375 % 6.375% | 1-5: 6: 7: 8: | $1,497.86 $1,871.61 $1,871.61 $1,871.61 |
*Based on available rates per LendingTree at time of publication
**Based on available rates from a general search at time of publication
A few things worth noting:
- The rate and mortgage payment on the 5/1 ARM could rise to the maximum lifetime cap (5.56% + 5%) after eight years.
- The rate and mortgage payment on the 5/5 ARM are still at the first adjustment cap (4.375% + 2%) after eight years.
Bottom line: The 5/5 ARM gives you more time to adjust to the higher monthly payment after your initial rate period ends than the 5/1 ARM.
Pros and cons of 5/5 ARMs
Here are some pros and cons of a 5/5 ARM:
| Pros | Cons |
|---|---|
Your initial rate is lower compared to a 30-year fixed loan You have more time between adjustments compared to 5/1 ARMs You could use the extra savings to pay your mortgage off faster You may qualify for a slightly higher loan amount because your rate and payment are lower | You’ll need to hunt around for lenders that offer 5/5 ARMs versus 5/1 ARMs You may end up with higher monthly payments after the fixed-rate period ends You’ll have to pay if you want a “conversion” option to switch to a fixed-rate Your home’s value could drop, leaving you stuck in an ARM you can’t refinance |
A 5/5 ARM comes with both benefits and drawbacks. Here are a few highlights to keep in mind when deciding if this is right for you:
- More borrowing power: A lower initial interest rate means a lower payment and debt-to-income (DTI) ratio, which means you may qualify for a slightly higher loan amount than you would with a 30-year fixed-rate mortgage.
- Paying for a conversion option. If you’re nervous about a higher future payment, you may want to ask about a conversion option on your 5/5 ARM. It allows you to switch to a fixed rate without completing a full refinance if rates drop. However, it usually comes with a cost in the form of a higher initial start rate.
How to decide between a fixed-rate and an adjustable-rate loan
A fixed-rate mortgage is typically the best option for borrowers who plan to stay in their home for the long haul and don’t want any fluctuations in their monthly payments.
On the other hand, the 5/5 ARM may be ideal for homebuyers who:
- Want to use the extra monthly savings to pay down their mortgages and build equity more quickly
- Expect substantial increases in earnings in the near future and can afford a higher potential payment
- Plan to sell their home before the five-year initial rate period ends