5/1 ARM vs. 5/6 ARM: Key Differences

Elevated home prices and rising interest rates have sparked renewed interest in home loans that can lower monthly mortgage payments, like adjustable-rate mortgages (ARMs). If you’re shopping for a home, take the time to understand this mortgage option. This article explores the key differences between 5/1 and 5/6 ARM loans, crucial when considering adjustable-rate mortgage options.

Traditionally, the most common type of these adjustable-rate mortgages has been the 5/1 ARM. However, mortgage lenders have recently transitioned to offering a 5/6 ARM instead of the conventional version of these loans. Although 5/1 ARMs and 5/6 ARMs serve similar borrowers, understanding a few key differences is essential.

What You Need to Know About 5/1 and 5/6 ARM Loans

Elevated home prices and rising interest rates have sparked renewed interest in home loans that can lower monthly mortgage payments, like adjustable-rate mortgages (ARMs). If you’re shopping for a home, take the time to understand this mortgage option.

Traditionally, the most common type of these adjustable-rate mortgages has been the 5/1 ARM. However, mortgage lenders have recently transitioned to offering a 5/6 ARM instead of the conventional version of these loans. Although 5/1 ARMs and 5/6 ARMs serve similar borrowers, understanding a few key differences is essential.

What is a 5/1 ARM?

A 5/1 ARM is a type of mortgage that features a variable rate. It maintains a fixed interest rate for the initial five years before adjusting annually thereafter. This introductory period is why it’s called “5/1.”

“The initial fixed interest rate with an ARM is typically lower than what is available with a conventional 30-year fixed-rate mortgage,” explains Jessica Visniskie, SVP of Capital Markets at AmeriSave. “However, once the rate begins to adjust, it may either increase or decrease, posing a risk of higher monthly mortgage payments over the long term.”

The rate adjustment is based on a financial index identified in your mortgage contract by the lender. Commonly used indexes include the Secured Overnight Financing Rate (SOFR) and the Constant Maturity Treasury (CMT). Previously used indexes like the London Interbank Offered Rate (LIBOR) are no longer utilized in the US after June 2023.

Upon adjustment, the lender adds the chosen index rate to a margin specified in your mortgage contract. While the index rate fluctuates, the margin typically remains constant for the loan’s duration.

Why are 5/1 ARMs transitioning to 5/6 ARMs?

Conventional US ARM loans, including 5/1 ARMs, historically relied on LIBOR as their index. However, due to questionable practices manipulating index rates, LIBOR is being phased out by June 2023. Lenders are adopting more accurate indices, like SOFR, for their conventional ARM loans. With SOFR’s six-month average, these loans now generally have a six-month adjustment period, leading lenders to offer 5/6 ARMs instead of 5/1 ARMs.

It’s important to note that government-backed ARM loans, such as those offered by the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA), still utilize the CMT index, which allows for a one-year adjustment period.

Interest rate capping for ARM loans

Irrespective of your ARM loan structure—whether it’s a 5/1, a 5/6, or any other type of ARM—your adjustable interest rate may be subject to caps. These caps restrict the amount by which your interest rate can increase.

• Initial Rate Cap: Limits the percentage points that can be added to the interest rate upon its first adjustment.

• Periodic Rate Cap: Sets the maximum percentage points that can be added to the interest rate upon subsequent adjustments.

• Lifetime Rate Cap: Establishes the total percentage points that can be added to the interest rate over the loan’s entire term. Interest rate caps are expressed as three numbers separated by slashes, such as 5/2/5. The first number represents the initial cap, the second the periodic cap, and the third the lifetime cap.

Interest rate caps are expressed as three numbers separated by slashes, such as 5/2/5. The first number represents the initial cap, the second the periodic cap, and the third the lifetime cap.

“An ARM loan isn’t suitable for everyone,” advises Visniskie. “However, if you plan to reside in the home for only a few years, it could be an excellent borrowing option. Alternatively, you can start with an ARM and refinance to a fixed-rate loan before the adjustment period begins, especially when interest rates drop below those available at the time of purchase.”

Understanding the operation of a 5/6 ARM necessitates grasping its unique structure.

Initial Fixed-Rate Period: Unlike traditional fixed-rate mortgages, a 5/6 ARM offers an initial fixed-rate period followed by adjustable rates.

Rate Stability: During the initial fixed-rate period, typically five years, the interest rate remains constant.

Adjustable Rates: Following this period, the rate adjusts annually based on market conditions and predetermined margins.

Considerations for Borrowers: Borrowers should be aware of potential rate fluctuations and plan accordingly. Seeking guidance from a financial advisor can provide clarity on the implications of a 5/6 ARM.

Let’s examine an example to better illustrate how a 5/6 ARM operates.

You sign a purchase contract for a $400,000 home and have enough saved for an $80,000 (20%) down payment.

Your lender offers two mortgage options:

• A 30-year fixed-rate loan at a 7.0% interest rate.

• A 5/6 ARM at a 6.0% introductory interest rate and 5/2/5 interest rate capping for the adjustment period.

Here’s how those loans would compare in the first five years.

Difference between 5/1 and 5/6 ARM loans

In this example, the 5/6 ARM saves you $159 per month or $12,600 in the first five years (60 months) of the mortgage. Opting for a 5/6 ARM can result in significant savings if you plan to relocate before the adjustment period concludes.

However, if you decide to stay beyond five years, the outcome hinges on interest rate adjustments. For instance, if the interest rate increases to 8.0% in the first adjustment, the monthly payment would rise to $2,348, surpassing the fixed-rate mortgage by $219. Further increases could erode your savings.

While interest rate caps provide some reassurance, preventing the loan from escalating more than 2 percentage points annually or 5 percentage points over its lifetime, there is a risk of negative amortization if your payments fail to cover interest costs.

5/1 ARMs vs. 5/6 ARMs

For borrowers, the primary difference between a 5/1 ARM and a 5/6 ARM lies in the duration between interest rate adjustments. A 5/1 ARM has a one-year adjustment period, whereas a 5/6 ARM adjusts every six months.

In fact, the aforementioned example applies equally to either loan type. The sole distinction is the frequency of interest rate adjustments, occurring every six months with a 5/6 ARM.

Refinancing a 5/6 (or 5/1) ARM to a fixed-rate mortgage

To evade the unpredictability of fluctuating interest rates and monthly mortgage payments, many ARM recipients planning long-term residency opt to refinance to a fixed-rate mortgage.

Continuing our example:

At the five-year mark, the interest rate on a 30-year fixed-rate mortgage declines to 4.25%. With approximately $100,000 equity and a home appraised at $425,000, you apply to refinance your 5/6 ARM to a 30-year fixed-rate mortgage.

Difference between 5/1 and 5/6 ARM loans

In this scenario, the 5/6 ARM saves money in the initial five years of the mortgage. Moreover, you pay significantly less than if you had chosen the fixed-rate loan initially. Additionally, the total cost of paying off both mortgages is lower than the original 30-year loan.

Savings through refinancing a 5/6 ARM necessitates planning. “You should conduct an ROI calculation,” advises Visniskie. “Anticipate rate increases with the ARM. However, refinancing incurs closing costs. Estimate the years required to recoup these costs based on the fixed loan interest rate. A loan officer can assist in this ROI assessment when making decisions.”

Types of ARM Loans

The 5/6 is not the sole ARM to consider. Lenders may offer various adjustable-rate loans, including:

• 5/6: Five-year fixed period; rate adjusts every six months thereafter.
• 7/6: Seven-year fixed period; rate adjusts every six months thereafter.
• 10/6: Ten-year fixed period; rate adjusts every six months thereafter.
• 5/1, 7/1, 10/1: Five, seven, or ten-year fixed period; rate adjusts every year thereafter.

AmeriSave offers these options solely as FHA or VA loans, which may transition to six-month adjustments following LIBOR retirement.

• Interest-only ARM — Pay only the loan interest for a designated period before transitioning to principal and interest payments.
• Payment-option ARM — Choose from multiple monthly payment options, including amortizing payments, interest-only payments, or minimum payments.

Pros and cons of 5/6 ARMs

Pros of 5/6 ARMs Cons of 5/6 ARMs Initial interest rates are usually lower than those available with a 30-year fixed-rate mortgage.

Difference between 5/1 and 5/6 ARM loans

5/6 ARM vs. 30-year fixed: Which is right for you?

Determining the optimal choice between a 5/6 ARM and a 30-year fixed-rate mortgage depends on your homeowner plans and risk tolerance.

If you anticipate relocating within a few years or believe interest rates will decline, a 5/6 ARM may yield savings with a lower mortgage interest rate. Conversely, if you plan long-term residency, prefer stable interest rates and payments, and are averse to refinancing, a 30-year fixed mortgage may be more suitable.

Qualifying for an ARM

Most lenders impose similar qualification criteria for a 5/6 ARM as for a fixed-rate mortgage.