5/1 ARM Loan: Most Popular Adjustable Loan in 2011

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The 5/1 ARM loan continues to be the most popular mortgage loan in the adjustable-rate category. But ARM loans as a whole still only account for about 7 percent of home-purchase loans. This is in stark contrast to their 2004 peak, when 40 percent of all purchase loans were adjustable. This is according to Freddie Mac’s 27th Annual ARM Survey.

What is a 5/1 ARM Loan?

The 5/1 ARM is often referred to as a “hybrid” loan, because it starts off like a fixed-rate mortgage before adjusting. In the case of the 5/1 hybrid ARM, the loan carries a fixed interest rate for the first five years. That’s what the first number signifies. After the initial fixed-rate period, the interest rate will begin adjusting every year. That’s what the second number signifies.

You can learn more about the 5/1 hybrid ARM loan in this article on our blog. The video below (courtesy of SketchNest.com), gives you an illustrated example of how these loans work.

According to Freddie Mac’s survey, nearly all lenders who offer adjustable-rate mortgages offer the 5/1 ARM variety. Some lenders offer hybrid loans with a longer term, such as the 7/1 and 10/1 ARM loans. These mortgage behave the same as the 5/1 ARM, but the initial fixed-rate period is seven or ten years respectively. These options are not as widely offered as the 5/1 hybrid. Only 64 percent of the surveyed lenders offered the 7/1 option, and only 23 percent offered the ten-year ARM.

The most popular mortgage category of all is still the 30-year fixed-rate mortgage.

Adjustable Mortgages Get a Bad Reputation

Adjustable-rate mortgages developed a bad reputation during the housing crisis. During the housing boom, mortgage lenders were using these loans to entice buyers. The loans would often come with a “teaser rate” that was significantly lower than the rate on a 30-year fixed mortgage. But when these loans started adjusting to a higher rate, many homeowners saw their mortgage payments double. This was widely reported in the news, which is why home buyers today are wary of the ARM loan.

“Homebuyers have shied away from ARMs because they are wary of the risks,” said Frank Nothaft, vice president and chief economist at Freddie Mac. “The potential for much larger payments if future interest rates are significantly higher … have led consumers to prefer fixed-rate loans instead of ARMs.”

Related story: The Decline of Adjustable Mortgages in 2011

When It Might Make Sense to Use an ARM Loan

In some home-buying scenarios, it might make sense to use an ARM loan. If, for example, you only plan to stay in the home for a few years, the 5/1 hybrid ARM might work out to your advantage. You could secure a lower interest rate for the first five years (when compared to a fixed-rate loan), and then you would sell the house before the uncertainty of the adjustment period.

Of course, if you’re unable to sell the home for some reason, you might be stuck with the ARM loan. This is what happened to hundreds of thousands of homeowners over the last few years.

You also have to consider the interest-rate differential between adjustable and fixed-rate mortgages. If the ARM loan rate is only slightly lower than the (more predictable) fixed mortgage, it wouldn’t make sense to take on the risk of an ARM. This is what we are seeing right now. According to Frank Nothaft of Freddie Mac: “Fixed-rate loans currently carry extraordinarily low rates, and initial ARM rates are only slightly lower, making fixed-rate product more attractive.”