5/1 ARM vs 10/1 ARM: Which Should I Get?

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Point of Interest

Choosing a 5/1 or a 10/1 ARM can help you get the lowest interest rate and save thousands on your next home.

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After the 2008 financial crisis, adjustable-rate mortgages, commonly known as ARMs, got a bad rap. Lenders were handing these loans out like candy, but many people weren’t aware that they’d struggle to afford this type of mortgage loan after the fixed interest rate ended and the interest rate began to fluctuate.

However, the reputation that ARM loans got wasn’t entirely fair. When you take the time to understand how an ARM loan works and carefully consider your options, you may find it’s an excellent option for your needs. Learning the difference between a 5/1 ARM vs. 10/1 ARM, along with each loan’s pros and cons, can help you decide which ARM option is best for you.

What is a 5/1 ARM?

A 5/1 ARM loan is much like your typical mortgage loan, but it differs by the type of interest rate it comes with. A 5/1 ARM offers borrowers a fixed interest rate for the first five years of the mortgage. Once that fixed term has ended, the mortgage rate becomes variable according to the index it’s tied to and updates on an annual basis.

As you go into the sixth year of your mortgage, you might find that your rate increases from the initial low intro rate. This also means your payments would increase. Of course, there’s the possibility the rate will drop, and you might find yourself with lower payment amounts. If that happens, you can keep paying your old payment to speed up your mortgage pay-off or just enjoy the extra room in your budget.

What is a 10/1 ARM?

What is a 10/1 ARM? A 10/1 ARM gives you a low interest rate for the first 10 years of the loan and then adjusts once a year. Like the 5/1 ARM, the variable interest rates on 10/1 ARMs are tied to specific indices that go up and down with the economy. When it’s time for your interest rate to readjust, you will see your payments go up or down. You can then expect to readjust your budget once a year for the life of the loan.

Pros and Cons

5/1 ARM

Pros

  • Low interest rates — 5/1 ARMs are attractive because they offer great intro rates, often well below the rates for a 30-year fixed-rate mortgage.
  • Rates may drop prior to the readjustment — Depending on the economy, interest rates may drop, and you can take advantage of another year or two of low rates after the fixed term ends.
  • You can build equity quickly — Since you aren’t paying as much in interest, your payments toward principle will help build equity faster.
  • A bargain for those who will move within five years — An ARM loan is perfect if you’re buying your starter home or are planning to move within the next few years. These types of loans allow you to take advantage of the low rates, and then do so again when you buy another home.

Cons

  • Lender contracts can be confusing — Financial institutions need to protect their business and make a profit, so contracts will be iron-clad. This means they might be confusing to you. You may end up agreeing to unfavorable terms if you’re not well-versed in financial lingo.
  • Rates may increase — One of the downsides of an ARM loan is that the variable rate often increases, not decreases. While you may have gotten a great deal for the first five years, you could end up paying more than someone who chose a fixed-rate mortgage.

10/1 ARM

Pros

  • Longer intro term — With a 10/1 ARM, you’ll enjoy the lower fixed interest rate for 10 years.
  • Budgeting will be easy — Since your mortgage payment will be a fixed amount, you can easily budget and use the money you save on interest to pay off debts or build savings.
  • Your ARM will most likely outlast your stay in the home — If the home you’ve bought is just a starter home, there’s a good chance you’ll be ready to move in 10 years. By realizing this and choosing a 10/1 ARM, you can take advantage of the interest savings while having the stability of a fixed-rate mortgage for the next decade.
  • You can buy more home. With a low fixed interest rate for the first 10 years, you can buy a larger house than you might be able to afford than if you’d chosen a fixed-rate mortgage with a higher interest rate.

Cons

  • There may be a prepayment penalty when you sell your home — Read and ask questions about the contract so you understand it thoroughly.
  • The interest rate and payment amounts may go up — When your interest rate increases after the initial 10-year term, you can refinance or sell to get out of the ARM loan, but both will come with additional costs.

How to choose?

Making the decision between a fixed-rate mortgage and an ARM requires consideration of your personal situation and what you expect the future holds.

When you take out a 30-year fixed-rate mortgage, you have the peace of mind from knowing your rates won’t go up because your interest rate is locked in. It’s a solid product for buyers who are risk-averse. You will know what your monthly payments are for the next 30 years, which will make budgeting and planning easier.

If you plan to stay in your house for the next 10 to 15 years, an ARM can still be an advantageous financial decision. You will enjoy a lower interest rate for the fixed portion of your ARM, saving a considerable amount over those who choose a fixed-rate mortgage. Unfortunately, there’s no crystal ball to tell you which way the ARM will adjust, but in the worst-case scenario, you can refinance to a fixed-rate mortgage if those rates are lower.

The final word

Deciding between a 5/1 ARM vs 10/1 ARM can be tricky. You might find that 5/1 ARM rates are lower than 10/1 ARM rates because lenders can more easily afford to offer the lowest interest rate for a shorter period of time. Aside from that variable, these two mortgage products are very similar and can be beneficial to saving money on your home purchase.

Charlotte Edwards

Contributing Finance Writer

Charlotte Edwards is an educator-turned-freelance writer based in Beijing, China. She writes personal finance and parenting content for both digital and print publications around the world. You will find her work on sites including The Penny Hoarder, Money Under 30, Work and Money, Incomes Abroad, Hawaii Parent and Tianjin Today. When not writing, you can find her spending time with her husband and two kids, or using her education degree to teach English as a Second Language.