5/1 ARM rates versus 15 year mortgage rates
As a rule, the 5/1 ARM rates are well below the 30-year fixed prices. As a rule, they are also lower than the 15-year fixed interest rate, but with a smaller gap.
According to our network of lenders, today's 5/1 ARM rates and 15 year fixed mortgage rates start at *:
Conventional 5/1 ARM
2.5% (2.743% APR)
Conventional 15-year celebrations
2.5% (2.743% APR)
Remember that your interest rate could be higher or lower than average depending on your credit, debt, income, down payment, and other factors.
When deciding between 5/1 ARM rates and 15 year fixed rates, you also need to consider factors such as the overall rate market and the length of your stay in your new home.
This is how you decide which loan program is best for you.
Find The Right Loan Program For You (November 12, 2020)
* The sampling rates assume a credit score of 740 and a deposit of 30 percent. See our tariff assumptions here.
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What is a 5/1 ARM?
A 5/1 ARM is actually a 30 year mortgage loan.
The “5” means that a fixed interest rate applies for the first 5 years of the loan. Thereafter, the interest rate can change every 1 year for the remaining 25 years depending on how the markets move.
An adjustable rate means your mortgage rate and your payment can increase after the 5 year fixed rate period. There is a chance they will fall too, but it is much less likely.
That is, a lender cannot increase your interest rate indefinitely. ARM rates can only go up or down a certain amount within constraints known as "Floors" and "Caps". (This is explained in more detail below.)
The amount by which the interest rate on your ARM loan adjusts depends on several factors:
The index rate (a published financial indicatorThe margin (the amount that is added to your interest rate above the index rate) limits the amount that an interest rate can rise or fall on a single adjustment to interest rate above a certain level) on which your mortgage rate is based
The start rate for a 5/1 ARM is traditionally 1 percentage point below similar 30-year fixed rates.
However, depending on the general interest rate environment, there may be a much larger or smaller gap between adjustable and fixed interest rates.
For example, in 2020 when mortgage rates were at record lows, there were times when ARM rates rose above fixed rates.
In this case, it is a unique time to get a fixed rate loan with an extremely low interest rate that won't change even if interest rates rise again in the future.
Find and Lock a Low Mortgage Rate (Nov 12, 2020)
What is a 15 Year Fixed Rate Mortgage?
Like the 5/1 ARM rates, the 15 year fixed mortgage rate is generally lower than the 30 year fixed rate (which is the standard for most mortgages).
However, there is a key difference between 15 year fixed loans and 5/1 ARMs.
With a 15-year fixed-rate mortgage, your interest rate is – as the name suggests – fixed for the entire loan term of 15 years. That means your tariff and payment will never change no matter what happens to the economy.
If you have a fixed rate mortgage, your loan terms may only change if you choose to refinance (be it at a lower rate, to pay off, or for any other reason).
Thanks to the security they offer, most borrowers choose a 30- or 15-year fixed-rate mortgage over a 5/1 ARM.
However, there are certain scenarios when ARM loans become increasingly popular – usually when interest rates are rising or when a homeowner is only planning to stay in their home for a few years. (Thus they can take advantage of the low fixed income period and move before their rate changes).
Low and high interest economy
2020 borrowers need to reassess their mortgage loan options and consider which loan is best for their refinance or purchase.
In a low interest rate environment, more borrowers are opting for fixed rate loans.
ARMs only included 2.5% Of all closed mortgage loans in September 2020, when interest rates were compared to record lows, ARMs made up for them by comparison 7.2% of all closed loans in September 2018 when interest rates were still rising
This is because when interest rates are generally low, there tends to be less of a difference (or “spread”) between adjustable and fixed interest rates.
And when the 5/1 ARM rates are close to the fixed rate for 15 years, there is much less incentive for borrowers to opt for a riskier loan. Why choose an ARM when you can set an interest rate that is nearly the same for the life of the loan?
Mortgage lenders are likely to see more ARM loan applications the next time interest rates rise a percentage point or more – whenever that happens again.
Before the real estate crisis in the late 2000s, homebuyers could find some pretty creative ARM programs. You could find loans with interest rates that change every month. Some even allowed their loan balances to be increased every month.
Today's ARMs are much safer. These loans start out as fixed rate mortgages for a period of three to ten years. After this introductory rate expires, they will be converted into adjustable loans for the remainder of the mortgage term.
The loans are basically a “mix” of a fixed rate mortgage and a variable rate mortgage.
Hybrid credit products will be reset after the introductory interest rate expires. However, interest rate changes are controlled by “interest rate caps” so that a borrower's interest rate and payment are limited. (More on caps later).
It is possible for ARM rates to go down but usually go up, meaning monthly mortgage payments go up too.
How the 5/1 ARM rates adjust
After the introductory period with fixed interest rates, the ARM rates can be adjusted every year. Whether or not your ARM rate changes – and how much it moves – depends on what interest rate index it is tied to.
Previously, most variable rate mortgages were based on an index called 1-year LIBOR. (LIBOR stands for London Interbank Offered Rate).
From 2020-2021, the majority of ARMs will be based on the SOFR index instead. SOFR stands for Secured Overnight Financing Rate.
To avoid the technical details, you need to know that SOFR is a measure of current interest rates across the entire credit market.
Your ARM rate would likely be based on the SOFR overnight rate plus a certain percentage. This is known as the "margin".
For example, let's say your current rate for a 5/1 ARM was 2.5%, but you are nearing the end of your 5 year fixed period.
The current SOFR overnight funding rate is 0.10%. The margin on your loan is 2.75 percent (this is pretty typical). If your interest rate adjusted on that day, your new mortgage rate would increase from 2.5% to 2.85% (index plus margin).
However, if the current SOFR rate were 1.5%, your rate would increase from 2.5% to 4.25% in one month. Your mortgage payment could go up hundreds of dollars. For this reason, it is important to consider the “worst case scenario” when accepting an ARM loan.
How do you determine your "worst case" payment? Continue reading.
ARM caps and bottoms
Your ARM rate offers more than just the base index and a few percentage points.
There are also rules in place that limit how much your rate can adjust. Imagine your starting rate was 3% and it was set for five years. Now your 5/1 is adjusting for the first time.
Assume the conditions are 2/2/5. This means your interest rate:
Can do not increase more than 2% at the first setting Can do not increase more than 2% for any future adjustment Can Never go higher than 5% Your initial interest rate
Its rate started at 3%, which means it can't be higher than 5% right now. And over the term of the loan, the interest rate can never exceed 8%.
As of this writing, Freddie Mac's average 5/1 ARM rate is 2.88%.
Is a 5/1 ARM a good idea?
A 5/1 ARM can work in your favor, but only under the right conditions. There is probably no reason to choose a 5 year ARM when fixed rate loans are available at similar or lower interest rates.
However, under normal market conditions, a 5/1 ARM is a good idea here.
The benefit of a 5/1 ARM is that you get a much lower interest rate and payment for the first few years of the loan that the interest rate is set.
If you're looking to sell in less than six or seven years, a 5/1 ARM might be a good choice. Over a five-year period, those savings could be enough to buy a new car or cover a year's tuition fees.
Note that the National Association of Realtors (NAR) sets the average time for owners to hold their properties at around seven years. Younger buyers sell earlier and older buyers tend to stay longer.
The main disadvantage of an ARM is the risk of interest rate hikes. For example, it is possible for the 5/1 ARM to increase with a start rate of 3% (in the worst case) as follows:
Beginning of the sixth year – 5% Beginning of the seventh year – 7% Years 8 to 30 – 8%
This doesn't mean your ARM will increase. it means that it is possible.
Advantages of a 15 year fixed loan
There is another way to secure the lowest possible interest rate – when you can afford higher payments.
Traditionally, the 15-year fixed-rate mortgage has an interest rate similar to that of the 5/1 ARM.
In today's market conditions, the 15 year fix can offer a discount of around half a percentage point versus the 5/1 ARM.
And unlike the ARM, the interest rate is fixed for the life of the home loan – you don't have to worry about rate hikes.
The catch? You have half the time to pay off your loan balance, so your monthly payments are higher. But while your loan will retire in half the time, your payment will NOT double. Not even close.
At the time of writing (November 2020), the average Freddie Mac interest rates on a loan amount of $ 300,000 are as follows:
30 years fixed – 2.81% 15 years fixed – 2.32%
The lower interest rate will keep your 15 year payment much lower than double your 30 year payment. At today's average Freddie Mac interest rates, the principal and interest payments on a loan of $ 300,000 would be:
30 year loan – $ 1,225 / month 15 year loan – $ 2,018 / month
Clearly, the downside to a 15 year loan is that it can be more difficult to afford the larger payment.
Find The Right Loan Program For You (November 12, 2020)
Fixed-rate mortgage versus ARM
If you only plan to keep your home (and mortgage) for a few years, the 5/1 ARM might be a good choice. At least under normal market conditions when the interest rate can be lower than that of the 15-year loan.
You also have the option to make a higher monthly payment if you want and can afford it. However, you are not tied to any payment obligation, which may be prohibitive.
If you plan to keep your home for an extended period of time and can comfortably afford the larger payment, the 15 year loan may be a better option.
However, before committing to a larger loan payment, check your finances and make sure you have done these things first:
Pay off any higher-interest debt, Maxed your 401 (k) if your employer offers matching contributions, and save two to six months of expenses in an emergency fund
As always, it is important to compare loan terms and rates based on your individual circumstances and long-term financial plans.
When does an ARM have to be refinanced?
Homeowners who currently have a 5 year ARM – or any type of ARM that is expiring – can set a low fixed rate in today's mortgage market and avoid changes in interest rates on the ARM loan.
You have a variety of refinancing options including:
Conventional Loans – These loans are regulated by Freddie Mac and Fannie Mae and must meet loan limits. Traditional loans have particularly low interest rates if you have good credit. And if you have at least 20 percent equity at the time of the refinance, you may be able to ditch PMI mortgage insurance. This would help lower your monthly paymentFHA loan – Insured by the Federal Housing Agency, these mortgages can offer homeowners competitive fixed rates. The FHA has one Withdrawal refinancing option for borrowers with a credit score of at least 600 in most cases and more than 20 percent home equity. You may have enough equity if you have paid a large down payment or live in an area with rapidly growing property valuesVA loan – Veterans and active service members can get refinance with a loan supported by the Department of Veterans Affairs. With a VA loan, a homeowner can refinance up to 100% of the home value and make a withdrawal if desiredUSDA Loans – With support from the U.S. Department of Agriculture, these loans are available to rural homeowners. Approximately 97% of the country's landmass falls under the USDA definition of "rural". To qualify for USDA funding, you must also meet income requirements, which means you cannot earn more than 115% of the median income in your area
All of these loan types offer fixed interest rates. USDA and VA loans often have the lowest interest rates, but not everyone can qualify.
For all types of loans except VA loans, the homeowner must pay the mortgage insurance premiums. With a traditional loan, you can avoid mortgage insurance if you keep 20 percent of the equity in the house.
Every time you refinance, you also have to pay the closing costs. However, with today's low fixed rates, closing costs would likely be dwarfed by the interest savings your new loan could provide.
Check your refinancing eligibility (November 12, 2020)
What are today's mortgage rates for 5/1 and 15 years?
The interest rates for 5/1 ARMs and 15 year fixed loans often track each other fairly closely. Make sure you get quotes for both programs when you contact competing lenders for mortgage deals.
Also, remember that mortgage rates are highly dependent on the buyer.
Your creditworthiness, debt-to-income ratio, repayment term, and down payment will all affect your actual interest rates on any type of mortgage.
The rates also vary depending on the lender. Many buyers can save a lot by simply shopping and finding the lender who can offer them the lowest interest rate and fees.
Check your new plan (November 12, 2020)