5/6 Hybrid Adjustable-Rate Mortgage (5/6 Hybrid ARM)

A 5/6 hybrid adjustable-rate mortgage (5/6 hybrid ARM) is an adjustable-rate mortgage (ARM) that has a fixed interest rate for the first five years, after which the interest rate can change every six months.

How a 5/6 Hybrid ARM Works

As the name indicates, a 5/6 hybrid ARM combines the characteristics of a traditional fixed-rate mortgage with those of an adjustable-rate mortgage. It starts out with a fixed interest rate for five years. Then the interest rate becomes adjustable for the remaining years of the mortgage.

The adjustable rate is based on a benchmark index, such as the prime rate. On top of that, the lender will add additional percentage points, known as a margin. For example, if the index is currently at 4% and the lender’s margin is 3%, then your fully indexed interest rate (the rate that you would actually pay) will be 7%. While the index is variable, the margin is fixed for the life of the loan.

A 5/6 hybrid ARM should have caps on how much the interest rate can rise in any given six-month period, as well as over the life of the loan. This offers some protection against rising interest rates that could make the monthly mortgage payments unmanageable.

How Are 5/6 Mortgages Indexed?

Lenders can use different indexes to set the interest rates on their 5/6 hybrid ARMs. Two commonly used indexes today are the U.S. prime rate and the Constant Maturity Treasury (CMT) rate. The London Interbank Offered Rate (LIBOR) index was once in wide use as well, but it is now being phased out.

While interest rates can be hard to predict, it’s worth noting that in a rising-interest-rate environment, the longer the time period between interest rate reset dates, the better it will be for the borrower. For example, a 5/1 hybrid ARM, which has a fixed five-year period and then adjusts on an annual basis, would be better than a 5/6 ARM because its interest rate would not rise as quickly. The opposite would be true in a falling-interest-rate environment.

5/6 Hybrid ARM vs. Fixed-Rate Mortgage

Whether an adjustable-rate mortgage or a fixed-rate mortgage would be better for your purposes depends on a variety of factors. Here are the major pros and cons to consider.

Advantages of a 5/6 Hybrid ARM

Many adjustable-rate mortgages, including 5/6 hybrid ARMs, start out with lower interest rates than fixed-rate mortgages. This could provide the borrower with a significant savings advantage, especially if they expect to sell the home or refinance their mortgage before the fixed-rate period of the ARM ends.

Consider a newly married couple purchasing their first home. They know from the outset that the house will be too small once they have children, so they sign up for a 5/6 hybrid ARM and take advantage of the lower interest rate until they’re ready to trade up to a larger home.

However, the couple should be careful to check the 5/6 hybrid ARM contract before signing it, to make sure that it doesn’t impose any costly prepayment penalties for getting out of the mortgage early.

Disadvantages of a 5/6 Hybrid ARM

The biggest danger associated with a 5/6 hybrid ARM is interest rate risk. Because the interest rate can increase every six months after the first five years, the monthly mortgage payments could rise significantly and even become unaffordable if the borrower keeps the mortgage for that long. With a fixed-rate mortgage, by contrast, the interest rate will never rise, regardless of what’s going on in the economy.

Of course, the interest rate risk is mitigated to some degree if the 5/6 hybrid ARM has periodic and lifetime caps on any interest rate rises. Even so, anyone considering a 5/6 hybrid ARM would be wise to calculate what their new monthly payments would be if the rates were to rise to their caps and then decide whether they could manage the added cost.

Is a 5/6 Hybrid ARM a Good Idea?

Whether a 5/6 hybrid ARM is right for you could depend on how long you plan to keep it. If you expect to sell or refinance the home before the five-year fixed-rate period expires, you’ll benefit from its generally low fixed interest rate.

However, if you plan to keep the loan past the five-year mark, you may do better with a traditional fixed-rate mortgage. Your payments may be somewhat higher initially, but you won’t face the risk of them increasing dramatically when the 5/6 hybrid ARM begins to adjust.

Bear in mind that there are many different types of mortgages to choose from, both fixed-rate and adjustable-rate.

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