5-6 Hybrid Adjustable-Rate Mortgage (ARM)
This is an ARM or adjustable-rate mortgage whose rate is fixed for the first five years and then adjusted every six months according to the fully indexed interest rate margin.
5-6 Hybrid Adjustable-Rate Mortgage Details
A mortgage loan with varying interest rates over its term is called a hybrid adjustable-rate mortgage. The rate depends on the attributed index. Interest rate adjustments are made in line with the market rate, responding to universally recognized rates for Constant Maturity Treasury (CMT), Cost of Funds Index (COFI), or the soon-to-be-defunct London Inter-Bank Offered Rate (LIBOR), among others.
ARMs offer more attractive interest rates in comparison to fixed-rate mortgages as they aim to compensate the borrower for rate fluctuations that may occur after the initial fixed-rate period. There is, however, a maximum interest rate ceiling or cap structure that is reset annually for the protection of mortgage consumers.
The interest rate cap structure for 5/6 ARMs determines how often and to what amounts the lender can adjust the loan's rates during its lifespan. When considering such a hybrid ARM, keep an eye on the ARM margin, a fixed percentage added to the indexed rate, which determines the mortgage's adjusted full indexed rate.
Example of a 5-6 Hybrid Adjustable-Rate Mortgage
If you intend to sell your home before that fixed-rate period is over, it might make sense to go with a 5-6 hybrid adjustable-rate mortgage. A young couple, for instance, considered by lenders first-time homebuyers, know that as their family grows, that house will start to feel smaller.
This hypothetical couple will have intentions to transition to a larger home by the time their mortgage interest starts the adjustment phase. A 5-6 hybrid ARM helps them enjoy the lower repayments of the 5-year fixed-rate duration, using the savings towards the second, more significant mortgage down payment.
With this type of mortgage structure, they'll pay less interest than a borrower whose loan has fixed interest throughout its term. Suppose they continue living in the house instead of moving, depending on how the indexed market rate behaves after their five years are up. In that case, this young family will either pay more costly payments or reap significant savings.
Significance of a 5-6 Hybrid Adjustable-Rate Mortgage
A hybrid 5-6 ARM structure features a rate adjustment of every six months after the initial five-year period expires, fluctuating to an indexed rate for popular indices like Constant Maturity Treasury and others. This rate adjustment makes the primary advantages of 5-6 hybrid ARMs lower interest rates and, when the indexed rate is favorable, affordable monthly payments.
The indexed or variable rate is used by banks and other financial institutions when lending money to each other. Simultaneously, the lender also charges a margin so it can reduce risk and cover its profits. This information helps if you plan to upgrade your living arrangements after the fixed-rate term expires, or you can refinance the mortgage loan like a short-term investment. You can also negotiate a specific margin with your mortgage provider depending on your loan amount, credit score, and down payment.
Types of a 5-6 Hybrid Adjustable-Rate Mortgage
A 5-6 hybrid ARM features an initial interest rate for payments that remains constant until after the fifth year reset date. Unlike with a standard ARM, which doesn't have an initial interest rate, 5-6 hybrid monthly payments are later determined by the six-month reset calculations of the sum of a banking rate index of choice plus a margin.
ARMs have three types of caps or adjustment limits within which the rate change can occur, both in frequency and amount.
- The initial rate cap limits how much the interest can change during the first-rate adjustment.
- The periodic cap refers to how much the rate can move between each of the concurrent reset intervals.
- The lifetime cap limits the amount the interest can change throughout the loan's term.
A typical cap on your 5-6 hybrid ARM will be 5% to 6% points for the initial, 2% points for the periodic, and 5% or 6% points for the lifetime cap. Rate caps can be structured in formats like 6-2-6, meaning that a 6% rate change will take effect when adjustments start, 2% with each subsequent change, and 6% for the loan's lifespan.
5-6 Hybrid ARM vs. 5-1 Hybrid ARM
Like a 5-6 ARM, a 5-1 ARM will have a fixed-rate period of five years, after which the lender adjusts the interest rate to the market indexed rate plus margin every year for the lifespan of the loan. You can snag a lower mortgage interest rate for repayments with a 5-6 or 5-1 hybrid ARM, whose most significant risk is the interest rate fluctuation after the expiry of the initial fixed-rate period.
Both 5-1 and 5-6 hybrid ARMs offer an initial teaser rate before adjusting to the fully indexed rate in fixed intervals, which adds a margin to the index rate. Some lenders allow mortgage buyers to choose an index, and others rely on any one of the major indices.
Synonymous with subprime mortgages before the real estate crisis, adjustable-rate mortgages like the 5-6 and 5-1 hybrids aren't inherently unsuited to today's housing market. The rate is adjusted every six months for a 5-6 or every year with a 5-1 ARM. With the current market conditions, this could considerably raise your payments.