Adjustable-rate mortgages (ARMs) offer a fixed rate for an initial period, then adjust annually based on an index plus a margin. A 5/1 ARM fixes the rate for 5 years, then adjusts once per year. A 7/1 ARM fixes for 7 years. The choice between them is almost entirely about the borrower's realistic holding period and their risk tolerance for the first adjustment.
Rate and Pricing Differences
In most rate environments, the 5/1 ARM prices 25 to 50 basis points below the 7/1 ARM. The 7/1 prices 25 to 50 bps below the 30-year fixed. On a $500,000 loan, a 0.375% difference between a 5/1 and 7/1 ARM is roughly $115/month. That monthly savings must be weighed against the 2 additional years of rate certainty the 7/1 provides.
ARM Cap Structure
Both products typically carry a 5/2/5 cap structure: the first adjustment cannot exceed 5% above the initial rate, each subsequent adjustment cannot exceed 2%, and the lifetime cap is 5% above the initial rate. Confirm the cap structure at application. Some lenders use 2/2/5 or 2/1/5. The first adjustment cap is the most important number for borrowers to understand when stress-testing the worst-case payment.
Matching the ARM to the Holding Period
- ✦Borrower plans to sell or refinance in 4 to 5 years: 5/1 ARM is the right product
- ✦Borrower plans to move in 6 to 7 years: 7/1 ARM captures more certainty at a modest premium
- ✦Borrower is uncertain about timeline: 7/1 ARM or 30-year fixed is the safer default
- ✦Investment property with a planned 3-year exit: 5/1 ARM or 3/1 ARM (if available) maximizes cash flow
Aria can compare 5/1 vs. 7/1 ARM payment scenarios and stress-test worst-case adjustments for any loan amount. Ask at vicariointel.com.
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