When to consider a 5/6 ARM loan

Quick insights

Buying your first home is an exciting milestone, but it can also feel overwhelming with the various terms and loan options to consider. If you’ve been exploring mortgage options, you may have come across the term “5/6 ARM.”

But what is a 5/6 ARM? Could it be what you need to finally get the keys to your dream home?

What does a 5/6 ARM loan mean?

A 5/6 adjustable-rate mortgage (ARM), or 5/6 ARM, is a type of home loan that’s amortized over a 30-year period, like a traditional fixed-rate mortgage. The difference is this loan has two key phases.

Part of what makes a 5/6 ARM appealing is that the initial fixed interest rate may be lower than what you’ll find with a traditional fixed-rate mortgage. This means you can save money upfront, which could be particularly helpful for first-time homebuyers trying to stretch their budgets.

However, this type of loan isn’t without risks. Since the rate adjusts regularly after the first five years, your monthly payments can fluctuate. If interest rates rise, your payments could increase beyond what your budget can handle. That’s why it’s important to weigh your options carefully before committing to a 5/6 ARM.

Other types of ARM loans

Though a 5/6 ARM is a common type of adjustable-rate mortgage, it’s not the only one out there, and all 5/6 ARMs aren’t the same. There are several variations, each catering to different needs.

Hybrid ARM mortgage

The 5/6 ARM is a type of hybrid ARM mortgage. Hybrid ARMs combine an initial fixed-rate period with an adjustable-rate period.

However, 5/6 ARMs aren’t the only type of hybrid ARMs. Two other common types are:

If you’re trying to choose between these options, know that it will likely depend on how long you plan to stay in the home and your tolerance for fluctuating payments.

Interest-only ARM

With an interest-only ARM, you pay only the interest for a set time at the beginning of the loan (typically 10 years). This results in lower monthly payments during that period.

Afterward, you’ll start repaying both the principal and interest, which could lead to a big jump in your monthly payments.

Payment-option ARM

A payment-option ARM gives you flexibility in how you pay back your loan each month. Options may include:

How a 5-year ARM mortgage works

To explain how a 5/6 ARM functions, let’s review key components that influence how payments are calculated.

First, there’s the benchmark index, sometimes referred to as the “prime rate.” With this, the lender ties the loan’s adjustable interest rate to a financial index, such as the Secured Overnight Financing Rate (SOFR). When the index goes up or down, your rate adjusts accordingly. Think of it as the base ingredient in the interest-rate recipe.

On top of the index, the lender adds a fixed margin, usually up to 5%. For instance, if the current index rate is 2% and your margin is 3%, your mortgage’s interest rate will be 5%.

Add the index and the margin together, and you get the total interest rate you’ll pay during the adjustable phase. For example, let’s say the index rate is 2.5% after your five-year fixed term, and your margin is 3.5%. Your new interest rate would be 6% for the next adjustment period.

The role of rate caps

To help prevent dramatic spikes in your payments, 5/6 ARMs generally come with rate caps, including:

Though they sound similar, differentiating between these caps can help you assess whether the loan fits within your long-term financial plans.

What happens after 5 years in a 5-year ARM?

Once the fixed-rate period ends, your interest rate will adjust every six months based on the current index rate and your loan’s margin. For example, if interest rates go down, your payments may decrease. However, if rates go up, your payments could be higher.

For first-time homebuyers, this unpredictability can be a concern, especially if your budget is already tight. That’s why some borrowers may choose to refinance into a fixed-rate mortgage after the first five years or sell the home before the fixed period ends.

5/6 ARM loan requirements

Like any other loan, there are a few checks you’ll need to meet before signing the paperwork for your 5/6 ARM loan.

However, remember that putting less than 20% down on a conventional loan usually requires private mortgage insurance (PMI), which will add to your monthly expenses.

Benefits of a 5/6 ARM loan

For first-time homebuyers, a 5/6 ARM loan can offer a few advantages:

Lower initial interest rates

One of the biggest draws of a 5/6 ARM is the lower initial rate compared to a traditional 30-year fixed mortgage. This reduced rate translates to more manageable monthly payments during those crucial early years when you’re getting settled into your new home.

Saves more money in the short term

If you're planning to move or refinance within five years, why pay more for the sake of locking in a 30-year fixed-rate mortgage? A 5/6 ARM allows you to enjoy lower upfront payments, making it easier to budget for the other costs of homeownership (or splurge on new furniture for your dream home).

Payment caps for predictable adjustments

While the adjustable-rate period does bring some uncertainty, most ARMs have caps in place. These caps limit how much your interest rate can increase (or decrease) during each adjustment and over the life of the loan. Knowing there’s a safety net can ease some of the “what if?” fears.

Flexibility for short-term ownership

If you’re not planning to live in your first home forever, a 5/6 ARM can be ideal. Planning to sell or upgrade in five to seven years? You’ll likely move on before adjustments even kick in.

Disadvantages of a 5/6 ARM loan

ARMs aren’t without their caveats. Here are some potential downsides worth considering before you sign on the dotted line.

Interest rates aren't always that much lower

The main appeal of ARMs generally lies primarily in their lower starting rates, but this may not always be true. Also, depending on the difference in the offered interest rate, you may find the benefit of long-term stability outweighs the short-term benefit.

Rate uncertainty after year five

Perhaps the most significant risk is the potential for your interest rate to rise (a lot) once the initial five years are up. Depending on market trends, payments could increase significantly, possibly creating financial strain.

Payment complexity

For first-time homebuyers, ARMs can have a more complex payment structure. With their shifting rates and loan terms, it’s easy to feel overwhelmed or miss key details that could come back to bite you.

Minimal benefit when rates are low across the board

ARMs tend to shine in high-interest-rate environments, where the initial lower rate provides noticeable savings. Unfortunately, if rates are already at a historical low, there’s less financial incentive to consider an ARM when a fixed rate offers long-term security.

Differences between a 5/6 ARM and fixed-rate mortgage

Choosing between a 5/6 ARM and a fixed-rate mortgage isn’t a one-size-fits-all decision. Here's a head-to-head comparison to help clarify.

Index changes

With a fixed-rate mortgage, the interest rate stays the same for the life of the loan. Therefore, your monthly principal and interest payments stay the same for the life of the loan. A 5/6 ARM, on the other hand, is tied to an index (like the SOFR). After the fixed-rate period ends, this index determines how much your mortgage rate adjusts. If market interest rates drop, your payment could get smaller. However, if rates rise, so do your payments.

Interest rates

Again, 5/6 ARMs typically start with lower interest rates than fixed-rate mortgages. This “teaser rate” can help keep your initial monthly payments manageable. But after that five-year initial period, the interest rate on a 5/6 ARM becomes much harder to predict.

This lower introductory rate might be tempting, but with a fixed-rate mortgage, you avoid surprises. Your rate stays constant no matter how the market shifts.

Monthly payments

ARMs involve uncertainty. Over time, market-driven rate changes can affect your monthly mortgage payments. If rates increase, your payments could rise suddenly and significantly after the adjustment period.

Fixed-rate mortgages keep things simple and predictable. If you’re the type who sleeps better knowing exactly what you’ll owe each month, fixed may be your better bet.

Qualification

One often-overlooked factor is loan qualification. Fixed-rate loans are sometimes easier to qualify for since they’re less risky for lenders. Qualifying for a 5/6 ARM could mean stricter requirements in some cases, like a higher credit score or larger down payment.

Tips for choosing a 5/6 ARM loan

If you’re still considering an ARM loan, here are a few tips to help you decide:

Look at your Loan Estimate to better understand the ARM

Your Loan Estimate is a three-page document that outlines key details about your mortgage. For an ARM, it includes the initial rate, adjustment periods and caps (which limit how much your rate can rise). Read it carefully and use this estimate to visualize what your loan could look like in different scenarios.

Pay attention to projected payments

A 5/6 ARM comes with varying payments after that initial first, five-year period. Projected payments highlight how much your monthly costs could increase when your rate adjusts. Before you sign, ask yourself tough questions like, “Can I afford my highest potential payment if rates soar?”

Consider the implications of the “teaser rate,” if applicable

Teaser rates are offered by some lenders to help make ARM loans seem more enticing (and ultra-affordable). But remember, teaser rates revert to a fully indexed rate once the initial period ends, and your monthly payment could skyrocket. If the initial “discount” feels too generous, find out what you’ll owe after the teaser ends.

Compare ARM offers

Every lender’s ARM terms are a little different. To find the best deal, compare:

Each of these affects how much you’ll pay over time, so study your options carefully.

Review the lender’s ARM program disclosure

This document dives into how the specific lender handles rate adjustments. It explains the index they use, the loan’s margin and any special terms.

See if there’s a conversion option

Some 5/6 ARMs include a feature that allows you to convert your adjustable mortgage into a fixed-rate loan in the future. This can be helpful, but make sure you understand the costs (and potential fees) before you commit.

Consider paying points

Paying points involves paying upfront fees at closing to lower your interest rate. With a 5/6 ARM, the discounted rate usually applies only during the initial fixed period. Run the numbers to determine if buying points offers a long-term benefit in your situation.

Is a 5-year ARM a good idea?

Whether a 5/6 ARM is a good fit depends on your financial situation and future plans. It could be a smart choice if you can handle future payment increases. Remember, if interest rates climb, so will your monthly payments.

Similarly, a 5/6 ARM might be a good fit if you’re planning to sell or refinance before the introductory period ends. If you’re only planning to stay in the home for a short period, a 5/6 ARM might save you money with its lower initial rate.

In summary

A 5/6 ARM loan starts with a steady rate, then adjusts to match market conditions. As long as you fully understand the terms of your ARM loan, whether you’re looking for lower monthly payments in the short term or plan to move soon, this loan type could be a smart move.

Still unsure if a 5/6 ARM is a good option? Reach out to a mortgage lender or financial advisor who can review your unique situation and help you find options for your homeownership goals. Homebuying is a big decision—but with the right tools and knowledge, it can be a little less daunting.