When you're in your 20s or even early 30s, 30 years can seem like an eternity. When you purchase a home, you also get to experience the "joy" of being in debt for as long as 30 years in many cases. However, if you don't intend to stay in your home for 30 years or even 10, a 5/1 ARM might be an option for you to get a lower interest rate.
A standard 30-year mortgage consists of a fixed interest interest rate, where the monthly payments remain the same for the duration of the loan. While an ARM may also last for 30 years, the interest rate can change at predetermined intervals. With a 5/1 ARM, the interest rate remains fixed for the first five years. After this initial term, the interest rate is re-evaluated on an annual basis, and could go up or down depending on market and economic conditions.
A benefit of the 5/1 ARM is that for the initial five-year period, the interest rate generally will be lower than that offered by a 30-year fixed product. If the home you're considering is a "starter" property and you're looking to upgrade in five years or less, then a 5/1 ARM can make perfect sense. It can also be the logical choice if you have the type of job or career that requires you to move frequently, as you're less likely to be concerned about long-term interest rates.
Choosing the 5/1 ARM over the 30-year fixed mortgage does introduce an element of risk. As the mortgage crisis of 2008 showed, many homeowners were ill-prepared for suddenly skyrocketing mortgage payments due to having an ARM where the interest rate increased dramatically. If you choose a 5/1 ARM and plan to stay in the home for many years, you probably should have some assurance that your chosen career path will lead to increased earnings over time so you can handle larger monthly payments if necessary.
If you're the conservative type who values stability, the 30-year fixed mortgage is probably the better choice. Although your mortgage may prove more costly than an ARM if interest rates trend lower for several years, you'll also never have to worry about what could happen if rates increase. Having a stable mortgage payment can also make long-range financial planning easier, and if your income continues to increase over the years, your monthly payments become even more manageable.