Is the 5-Year ARM Loan a Good Option for California Home Buyers?

Is the 5-year ARM loan a good mortgage option for California home buyers? Sometimes yes, other times no.

The key is to understand how these mortgage loans work over the long term, and to make an informed decision based on that. So let’s take a closer look at the 5-year adjustable-rate mortgage loan, and when it might make sense to use one.

How a 5-Year Adjustable-Rate Mortgage Works

Some home buyers in California use the 5-year ARM loan as a way of saving money over the short term. While it’s not nearly as popular as the more widely used 30-year fixed mortgage, the ARM does have its advantages.

But let’s start with a definition and move on from there.

You might see this type of mortgage loan labeled as a “5-year ARM” or a “5/1 ARM.” In most cases, these terms are used interchangeably and refer to the same product. It’s an adjustable mortgage that carries a fixed interest rate for the first five years, and adjusts annually thereafter.

Generally speaking, 5-year ARM loans tend to start off with a lower mortgage rate, compared to the more popular 30-year fixed home loan. That’s their primary appeal. They can be a money-saver over the short term.

Is the 5-Year ARM a Good Idea for Your Situation?

So, when does it make sense to use this kind of mortgage product? What types of home buyers in California might benefit from using a 5-year ARM loan? Let’s shift gears and examine the pros and cons.

Here are some important questions to consider:

• How long do you plan to stay in the home? If you plan to stay beyond five years (when the loan starts to adjust), how much higher might the rate go?
• How much can the rate rise at the first adjustment, after the initial fixed phase has expired? In most cases, there’s a limit to how much the rate can rise on its first adjustment. Research “initial rate cap for ARM loans” to learn more about this.
• Would you still be able to afford your monthly mortgage payments if the rate went up by a quarter of a percent, half a percent, one percent, etc.?
• If you plan to keep the loan beyond the 5-year fixed period, are you comfortable with the idea of an annually adjusting mortgage rate?

If you only plan to keep the loan for five years or less, some of these questions are a moot point.

For instance, maybe you’ll only be in the home for three or four years. In that scenario, you could sell the house and move before the 5-year fixed period expires. It might be a good idea to use a 5-year adjustable mortgage product in this scenario, especially if your primary goal is to minimize your monthly payments.

Related: Fixed vs. adjustable for first-time buyers

Refinancing Before the First Adjustment

Some California home buyers who use the 5-year adjustable mortgage end up refinancing before the first adjustment takes place.  If you can refinance your home before the “fixed phase” expires, you could avoid the interest-rate uncertainty that occurs after that point.

This strategy is used by borrowers who want the best of both worlds. They want the lower rate that comes with a 5-year adjustable loan, but they don’t want to experience the fluctuation and possible increases that come in the later years. So they take out a 5/1 ARM and refinance at some point before the 5-year mark.

Will this strategy work for you? It might. Just bear in mind there are certain requirements for mortgage refinancing. California homeowners who want to refinance usually need good credit, sufficient equity, and enough funds to cover their closing costs.

If you think there is a high likelihood you’ll be able to refinance before the first adjustment period, then a 5-year ARM loan might be a good strategy for you.

Ready to explore your options? Located in the San Francisco Bay Area, Bridgepoint Funding serves home buyers and homeowners all across the Golden State. We have access to a large number of loan products, including both fixed and adjustable mortgages. Contact us with your financing questions or to apply for a loan.