Differences Between 5/1, 7/1, and 10/1 ARMs
An adjustable rate mortgage (ARM) actually begins with a term period where the introductory interest rate is locked in and cannot change. After this time passes, the rate is adjusted on an annual bases via a preset formula devised by the lender, thus affecting monthly mortgage payments. Several of the most common ARM conditions are indicated as 5/1, 7/1, and 10/1 ARMs.
How 5/1, 7/1 and 10/1 ARMs Differ
With a 5/1 ARM loan, the interest rate is locked for five years, and then adjusted for twenty-five years (if this is a 30 year loan term). With 7/1, the interest rate is locked for seven years and adjust for twenty-three. For a 10/1 adjustable rate loan, the interest is set for ten years and adjusted for twenty years.
ARMs are generally considered a riskier loan model because the interest rates almost always increase after the introductory time period expires. However, the upfront benefit of lower rates and monthly payments can be beneficial to borrowers who only intend to be in a home for a few years or expect their income to increase and offset potential ARM advances. You can determine how much your ARM rate will adjust (and whether it will increase or decrease) according to the margin and index it is tied to. While the margin is constant, the index provides the variable component of the loan.
An index should be regularly published and publicly available, often associated with organizations such as the U.S. Treasury Bill, the Constant Maturity Treasury, or the London Interbank Offered Rate. The combination of the index rate and margin rate is what then gives you the full loan interest rate.
Which ARM is right for you?
If you are trying to choose between a 5/1 ARM, 7/1 ARM, or 10/1 ARM, realize that there is no one across-the-board answer that is right for everyone all the time. You have to be able to gauge how much risk you are willing to take and whether you feel index rates are going to increase over the coming years—or at least in the period after the loan’s introductory rate expires. There are also important differences that will be specific to each lender and loan type, such as annual adjustment caps. In general, lenders will have priced ARMs so that they are rather indifferent to which one a borrower will choose. Generally, it’s a matter of the borrower deciding if they want to pay a bit more interest in the long run in order to enjoy a longer period of protected rates upfront.