A 5/1 ARM (Adjustable Rate Mortgage) is a type of hybrid ARM where the interest rate remains fixed for the first 5 years and then adjusts annually based on an index plus a margin. Here are the details on how 5/1 ARMs work:
- Initial Fixed Rate Period: For the first 5 years, the interest rate is fixed and does not change. This provides borrowers with stability and predictability in their monthly payments during this period.
- Adjustment Period: After the initial 5-year fixed period, the interest rate adjusts annually. The new rate is determined by adding a margin to the current index
rate.
- Interest Rate Caps: There are limits on how much the interest rate can change. For example, a 5/1 ARM may have caps such as:
- Initial Adjustment Cap: The maximum amount the interest rate can increase or decrease at the first adjustment after the fixed period.
- Subsequent Adjustment Cap: The maximum amount the interest rate
can change at each subsequent annual adjustment.
- Lifetime Cap: The maximum amount the interest rate can increase over the life of the loan.
- Examples of Caps:
- A 5/1 ARM Plan 3550 has a 1/1/5 cap, meaning the rate can increase by
a maximum of %1 at the first adjustment, 1% at each subsequent adjustment, and a total of 5% over the life of the loan
- Another 5/1 ARM Plan 3640 has a 2/2/6 cap, meaning the rate can increase by a maximum of 2% at the first adjustment, 2% at each subsequent adjustment, and a total of 6% over the life of the loan.
- Qualification: For UWM's 5/6 ARMs, the qualification is based on the greater of the Note Rate + 2% or the Fully Indexed Rate. The caps for these ARMs are
2/1/5 121.
In summary, a 5/1 ARM offers a fixed interest rate for the first 5 years, followed by annual adjustments based on an index plus a margin, with specific caps on how much the rate can change at each adjustment and over the life of the loan.
