How does a 5/1 ARM work? An adjustable-rate mortgage fixed for the first five years, then adjusting once a year for the remaining twenty-five within the caps written into the note.
A 5/1 ARM is a 30-year mortgage whose rate holds for five years and then resets once a year for the remaining twenty-five. The two numbers say exactly that: five years fixed, then one adjustment a year. It amortizes over thirty years throughout, so the payoff date never moves; the payment is rebuilt each time from the balance left and the new rate. Most new adjustable loans are now written 5/6, which is the same five-year fixed period with an adjustment every six months instead of every twelve, since the market moved to SOFR and the six-month reset came with it.
After the fixed period the rate is index plus margin. The index moves, commonly a SOFR average published by the New York Fed; the margin is a fixed number of percentage points written into the note and it never changes. Index plus margin is the fully indexed rate, and caps then limit what the note may actually charge: a cap on the first adjustment, a cap on each one after it, and a lifetime cap over the start rate. They are commonly written 2/1/5 or 5/2/5, and the order is not universal, so the note is what to read rather than the shorthand. Worked at $400,000 with a 5.75 percent start rate, principal and interest are about $2,334 a month against about $2,528 on a 30-year fixed at 6.5 percent. After sixty payments the balance is about $371,000, and a first adjustment that goes the full 2 points to 7.75 percent re-amortizes it over the remaining 300 months at about $2,803, up $468 a month. At a 10.75 percent lifetime ceiling the same balance is about $3,570.
The trade is about time. Five years at $194 a month less is roughly $11,600, and it is paid for by carrying every adjustment after that. It is a fair trade for a buyer who knows the home is a five-year home and a poor one for a buyer who plans to stay, because refinancing out depends on rates and on qualifying again and neither is promised. Regulation Z requires warning: 12 CFR 1026.20(d) puts the first rate change notice in the mail 210 to 240 days before the first payment at the new level, and 12 CFR 1026.20(c) requires 60 to 120 days for each one after. Lenders also qualify a five-year ARM at the greater of the note rate and the fully indexed rate, so the lower start rate buys a lower payment and not a larger loan.
A worked example
$400,000 on a 5/1 at 5.75 percent with 2/1/5 caps: about $2,334 a month for five years against about $2,528 on a 30-year fixed at 6.5 percent, roughly $194 a month less, or about $11,600 over the fixed period. After sixty payments the balance is about $371,000. A first adjustment to the 7.75 percent cap makes it about $2,803, and the 10.75 percent lifetime ceiling would be about $3,570.
Compare a payment at two rates
Questions people ask
What happens after 5 years on a 5/1 ARM?
The rate is rebuilt from the index plus the margin in the note, limited by the initial cap, and it repeats every year after that within the periodic and lifetime caps. The payment re-amortizes the remaining balance over the years left each time, so it can fall as well as rise.
Is a 5/1 ARM a good idea?
It depends on how long the home is held. A buyer who is certain to sell or refinance inside five years pays less for those years, while a buyer who stays carries every adjustment and is owed no refinance. This is general information, so run both payments and ask the lender for the note's caps and margin before deciding.