5/1 Florida Mortgage ARM
In simplest terms a 5/1 ARM (Adjustable Rate Mortgage) is a mortgage loan which will have a fixed rate of interest for the first five years, then the rate of interest will change every year thereafter for the remaining life of the loan. Also note, most ARM loans can be interest only or amortizing.
The trick in understanding the 5/1 ARM however is not the rate of interest for the first five years, this will be clearly disclosed to the borrower at the front end. The important thing to know about this type loan is what happens to your interest rate after the first five years. In other words, how will future rate change calculations be made, what are the limits, if any and how much can my payments increase in the future?
Key terms and calculations for these types of loans can vary widely. Let’s begin by understanding the basic concepts embedded within all ARM’s:
The four key concepts along with an understanding of key terms for ARM’s are described below:
First key concept: (Future Adjustment Calculations): All ARM loans will have a predetermined financial Index and a predetermined Margin.
What is an Index: For our purposes it is a “Reference Point” against which measurements are taken for making future adjustments. Examples of Indices: Wall Street Journal prime, Federal discount rate, Fed funds rate, 10 year treasury rate or a host of many others. Lenders are required to identify an index to be used in your interest rate calculations which you the borrower can readily have access to. The most widely used index used in the 5/1 ARM is the one-year treasury security index. The reason this is the most popular index is because it assists the lender in predicting their future annualized cost of funds (A this topic for another article). The important things to know about the index is how to find the current value and it is constantly changing.
What is a margin: To keep it most simple for our short discussion, the margin is an arbitrary numerical value which is added to your index in order to calculate your future interest rate changes. Your margin is set at the beginning of the loan and then remains the same for the life of the loan.
For example purposes: Say your lender had chosen a margin of 2.75% for the life of your loan. To calculate your interest rate for the next period we would simply add the margin to the current index. Say your current index was 2.87%, adding the two together would be your new rate of interest until the next change period ( 5.62%). Many times for simplicity the lender will round to the nearest .125%.
The second key concept to understand about ARM loans is the frequency of your interest rate changes after the initial fixed rate period. In the case of the 5/1 ARM we have already discussed that your rate of interest will change every year after the initial fixed rate period. This of course would be different if your local lender wanted to offer you a 5 Year ARM, which would imply that the interest rate only changed every five years.
The third key concept is whether or not your loan has periodic interest rate caps. In other words, how much can your interest increase at any given change date? Also embedded in this concept is “Life of Loan Cap”. In other words, is there a life time maximum interest rate? This information is also required to be disclosed to you. Common among 5/1 ARM terms, maximum interest rate increases are 2% annual and 5% maximum increase over the life of your loan.
So with all this unknown jargon and complexity why would someone want a 5/1 ARM over a 30 year fixed rate mortgage? Usually the 5/1 will always offer a lower mortgage rates compared to the 30 year fixed mortgage rate. If you are planning on selling within 5 years start counting your savings.
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I am under contract on a home now and I am considering a 5/1 or a 3/1 adj. rate loan over a 30 yr. fixed. I am going to sell my current home before the end of the year then either pay off the mortgage on the new house or refinance it on a 10 year fixed note for the remaining 50 or 60 thousand balance after it is payed down with the proceeds for selling my current home. Is this a good choice and also what will my closing costs be? The purchase price of my new house is 325,000. I’ll put down 20%. My new mortgage is for 260,000.
Thank you for your help!
Jeff,
Great questions here. Let’s address each question/comment in the order your wrote them in.
The 3/1 or 5/1 arm’s are very attractive right now based on the minimal mortgage payment because of the rates being really low, but that being said you want to make sure you will either refinance, sell the home, or pay off the total mortgage in full by the end of the term. The mortgage payment is amortized over 30 years, but the interest rate is only fixed for a period and then may adjust after that (the rate may rise).
We highly recommend this program to all homeowners that are planning for short-term change. We advise staying away from the program if you are staying in the home more than the 5 or 7 year period. It seems likely that rates will increase in the future and so will the mortgage payment if rates rise when your adjustement is going to take place.
As far as paying off your mortgage with leaving a minimal balance it may be good to hear advice from a financial planner, but usually if the interest rate is lower than the “average” annual return on your investment it’s best to leverage the money and put it towards the home later. That being said, sometimes emotions can play a part in the process too and you may be more comfortable with paying it off, so do what makes you comfortable.
Your typical closing costs run generally around 1%-1.5% of the loan amount (this includes lender fees, broker fees, title work, state/government fees), but it does not include escrows (you have the choice to waive them).
Thanks for the question.