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What Is a 5/6 ARM Loan?

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When it comes to mortgages, there’s no one-size-fits-all solution. But there are lots of options. Your job as a borrower is to understand all your options. When you apply for financing to buy a home, an adjustable-rate mortgage (ARM loan or ARM) may be one of your options. And a 5/6 ARM is one of the most common adjustable-rate loans available.

A 5/6 ARM is a type of adjustable-rate mortgage that comes with a fixed interest rate for the first 5 years of the loan. After the initial fixed-rate period, the interest rate adjusts every 6 months. 

Let’s take a closer look at 5/6 ARMs and what they offer as a popular home buying option. 

What Is an Adjustable-Rate Mortgage (ARM)?

Typically, an ARM is a mortgage that has a fixed interest rate for a set number of years. After that, the mortgage rate changes periodically until the loan is paid off.

ARMs are usually expressed in two numbers. The first number represents the years you’ll pay the fixed rate, which is also called the initial fixed-rate period or introductory period. The second number is the adjustment period, or adjustable-rate period. The second number indicates how often your interest rate will adjust after the introductory period.

Banks and other private lenders offer different types of ARMs. You may qualify for a 5/1 ARM, a 7/6 ARM or a 10/6 ARM.

In many cases, a borrower can get a lower introductory interest rate with an ARM than with a fixed-rate mortgage. However, that can change quickly after the introductory period ends.

How Does a 5/6 ARM Work?

A 5/6 ARM is an adjustable-rate mortgage with a fixed interest rate for 5 years. After that, the rate can change every 6 months. Most 5/6 ARMs have a total loan term, or repayment period, of 30 years.

The first 5 years of a 5/6 ARM are predictable. The interest rate is fixed, so every monthly mortgage payment is the same. You can find the fixed rate, or the initial interest rate, in your Loan Estimate. 

In year 6, things start to change. The interest rate will adjust every 6 months based on two factors: the market index rate and the margin.

The ARM index rate

The market index reflects the general amount of interest lenders charge when they approve financing. Your lender will choose a specific market index, such as the Secured Overnight Financing Rate (SOFR), which uses financial market indexes like the constant maturity treasury. Your interest rate will usually adjust up or down based on changes in the index.

Lender margins and interest rates

In addition to the market index, lenders will add a few extra percentage points to arrive at your final mortgage rate. This is known as the margin, and it helps lenders recover the costs of managing a loan and reduce their level of risk.

The total margin used to determine your final mortgage rate will depend on your financial background. Credit scores, level of income and ongoing debts all indicate how much of a risk a loan applicant presents, and lenders use those indicators to come up with an appropriate margin. 

While adjustable-rate mortgages change in accordance with the ARM index and housing market at large, the margin points attached to a mortgage are fixed and remain constant throughout the life of the loan. In other words, it’s the market index that changes when ARMs adjust, not the margin.

To calculate your interest rate, which is called the “fully indexed rate,” the lender adds the index to the margin. For example, if your margin is 2% (2 percentage points) and the index is 4%, you’ll pay a fully indexed rate of 6% in interest. 

Your lender can change the interest rate every 6 months. But to protect borrowers from steep interest rate increases, lenders set an interest rate cap. This cap limits the maximum interest rate you can be charged, also known as the ceiling, and each rate adjustment.

Adjustment period (adjustable-rate period)

While you’re looking at different ARM options, it’s a good idea to consider the adjustment period. With a 5/6 ARM, your interest rate and monthly mortgage payment can change every 6 months after 5 years. If index rates drop after the adjustment period, you’ll save money. But if the rates increase, your loan will cost you more. 

Compare that to a home loan with a longer adjustment period, such as a 5/1 ARM. If your interest-rate adjustment happens when the index rates are low, you’ll lock in the cost savings for a full year – as opposed to 6 months with a 5/6 ARM. 

But the opposite is also true. If the rate change for your 5/1 ARM occurs when rates are high, you’ll be locking in a higher interest rate for a year. With a 5/6 ARM, the higher interest rate may lower after 6 months.

5/6 ARM rates vs. fixed rates

When shopping for a mortgage loan, you may need to choose between a fixed-rate mortgage and an ARM. With a fixed-rate mortgage, the interest rate stays the same for the life of the loan. With a 5/6 ARM, your interest rate can go up or down twice a year starting in year 6. 

To make sure your ARM payments don’t get out of control, lenders typically use a cap structure. Caps set limits on the interest rate. There are a few caps to consider:

Interest rate caps

  • Initial cap: This cap lays out the maximum increase a lender can make on the first adjustment to your interest rate. If your fixed mortgage rate is 3% and the initial cap is set at 1 percentage point, the lender can’t charge more than 4% in interest – regardless of the index rate.
  • Per-period (periodic) cap: The cap limits how much a lender can increase your interest rate every adjustment period. 
  • Lifetime cap: The lifetime cap is the maximum possible interest rate your bank can charge. If your initial fixed rate was 3% and you have a 5% lifetime adjustment cap, your maximum interest rate (the ceiling) is 8%. You’ll never pay more than 8%, no matter what happens with the index. 

You can usually find these caps in the adjustable interest rate (AIR) table on your Loan Estimate form.

Example of a 5/6 ARM

How does this play out in the real world? Let’s look at an example.

Say your lender offers you a 5/6 ARM with an initial rate of 4%. Your margin is 2%, each increase is capped at 2% and the ceiling on your interest rate is 8%.

Years 1 – 5

  • You pay a fixed interest rate of 4%.

Year 6

  • First 6 months: The index rises to 4.5%. Because your rate increases are capped at 2%, your interest rate increases to 6% (4% initial rate + 2% maximum periodic increase).
  • Second 6 months: The index is still at 4.5%, so your rate rises to a fully indexed rate of 6.5% (2% margin + 4.5% index).

Year 7

  • First 6 months: The index jumps to 6%, so your interest rate becomes 8% (2% margin + 6% index).
  • Second 6 months: The index climbs to 6.5%. Because your interest rate ceiling is 8%, your rate doesn’t increase, and you continue to pay 8%.

In this scenario, your interest rate increases from 4% to 8% between the end of year 5 and the start of year 7. Depending on how much you borrowed, your monthly payments could rise by $500 or more.

Did you notice that while the index changes, the margin stays the same? That’s why it’s so important to look at the margin when comparing ARM options. A lower margin means a lower monthly payment and reduced interest overall.

Now, let’s imagine you’re comparing the 5/6 ARM with the 4% initial rate to a 30-year fixed-rate mortgage loan with a 5.5% interest rate. It’s helpful to look at three factors:

  • Payments in the first 5 years: If you choose the fixed-rate mortgage, you’ll pay 1.5% more in interest for the first 5 years. So if you’re borrowing $200,000 at 5.5% interest, your monthly payment before mortgage insurance and taxes will be around $1,136. With the 5/6 ARM, you’ll pay around $898 per month for the first 5 years.
  • Payments from years 6 – 30: With the fixed-rate loan, your monthly mortgage payments would always be $1,136. If you chose the ARM and the rates rise to the 8% ceiling, you could end up paying $1,468 a month. 
  • The total cost of the loan: As interest rates rise on an ARM, the total cost of your loan increases. You may end up paying tens of thousands of dollars more in interest over the life of the loan.

What Are the Advantages and Disadvantages of a 5/6 Arm Loan?

Like any mortgage, a 5/6 ARM has its advantages and disadvantages. Because all ARMs aren’t created equal, before you choose one, consider how the loan compares to other options. 

PROS of a 5/6 ARM👍

Begin with a lower interest rate

Compared to fixed-rate mortgage options, 5/6 ARMs typically start borrowers with a lower interest rate, helping them save money at the start of the mortgage’s term.

Take advantage of interest rate drops

When the fixed rate period ends, there’s a chance interest rates will have dropped. When this happens, borrowers with a 5/6 ARM can enjoy a new interest rate that sets them up with a lower monthly mortgage payment.

CONS of a 5/6 ARM👎

Potential increase in monthly mortgage payments

While there’s a chance interest rates could drop, there’s also the possibility they could rise. If that happens, borrowers with a 5/6 ARM will end up paying more each month.

Prepayment penalties

Borrowers with an adjustable-rate mortgage may be subject to prepayment penalties if they decide to refinance or sell their home.

Difficulty budgeting for the future

Without a fixed interest rate, it can be difficult for borrowers to understand how much money they’ll need down the line to cover their mortgage.

Is a 5/6 Arm Right for You? 

The right mortgage for you depends on your current financial situation and your future plans. If you want affordable payments for a few years, a 5/6 ARM could be the right choice. If payment predictability is more important to you, a fixed-rate loan might be a better solution.

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As you consider a 5/6 ARM, ask yourself these questions:

  • Are you planning to sell the house before the 5-year introductory period is up?
  • By how much will your payments increase after the first adjustment?
  • Are there caps on the interest rate?
  • Can you afford the maximum monthly mortgage payment?
  • Can you easily adjust your finances to accommodate any potential changes to your monthly mortgage payment every 6 months?
  • When will the bank notify you of a payment adjustment?
  • Is your income going to be predictable for the next 10 – 20 years?

The mortgage you choose will impact your finances in the present and the future. Whether you choose a 5/6 ARM, another type of ARM or a fixed-rate loan, read the fine print and compare your options.

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The Short Version

  • A 5/6 ARM is an adjustable-rate mortgage that has a fixed interest rate for 5 years. After that, the rate can change every 6 months
  • Most 5/6 ARMs have a total loan term (repayment period) of 30 years
  • It’s possible to pay off a 5/6 ARM early, but be sure to read the fine print. Lenders may charge a mortgage prepayment penalty
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