What is a 5/1 ARM mortgage? A mortgage with a fixed rate for an opening period and a rate that resets on a schedule after it, moving with a published index within caps written into the note.
An adjustable-rate mortgage is fixed at the start and floating afterwards, on a 30-year amortization throughout. The two numbers in the name say where the line falls. The first is the years the opening rate holds; the second is how often it adjusts after that, in years on older loans and in months on current ones. A 5/1 adjusts once a year after five years. A 5/6 adjusts every six months after five, and 5/6, 7/6 and 10/6 are the shapes written now, since the market moved from LIBOR to SOFR and the six-month reset came with it.
After the fixed period the rate is rebuilt each time from an index plus a margin. The index moves, currently a SOFR average published by the New York Fed; the margin is a fixed number of percentage points written into the note. Index plus margin is the fully indexed rate, and caps then limit what the note may actually charge: an initial cap on the first adjustment, a periodic cap on each one after, and a lifetime cap over the start rate. A note marked 2/1/5 caps the first move at 2 points, each later move at 1, and the whole loan at 5 above the start. Worked at $400,000 and a start rate of 5.75 percent, the payment is about $2,334. If the first adjustment goes the full 2 points to 7.75 percent, the balance of about $371,049 re-amortizes over the remaining 300 months at about $2,803, an increase of $468 a month. At the 10.75 percent lifetime ceiling the same balance is about $3,570.
Whether the opening rate sits under a fixed rate depends on the yield curve at the time, not on a rule, and it has been both in the last few years. Qualifying is separate from pricing: ability-to-repay rules require the payment to be tested above the teaser, and the agencies qualify an ARM with a fixed period of five years or more at the greater of the note rate and the fully indexed rate, with a rate uplift on shorter fixed periods.
A worked example
A $400,000 5/6 ARM starts at 5.75 percent with 2/1/5 caps: $2,334 a month against $2,528 for a 30-year fixed at 6.5 percent, about $194 a month less for the first five years. After 60 payments the balance is about $371,049. If the fully indexed rate is at or above the cap by then, the rate goes to 7.75 percent and the payment re-amortizes over 300 months at about $2,803, up $468. At the 10.75 percent lifetime ceiling it would be about $3,570.
Compare a payment at two rates
Questions people ask
What does 5/1 ARM mean?
The rate is fixed for the first five years and then adjusts once a year for the remaining twenty-five, within the caps in the note. The newer equivalent is written 5/6, where the adjustments come every six months instead of every twelve.
What index do adjustable-rate mortgages use now?
Most new ARMs use a SOFR average, the secured overnight financing rate published by the New York Fed, after LIBOR was retired. The note names the index and adds a fixed margin to it; the margin never changes, so all the movement comes from the index.