What is a 5/6 hybrid ARM?
A 5/6 hybrid adjustable-rate mortgage (ARM) is a mortgage that carries a fixed interest rate for the first five years and then converts to an adjustable rate that can change every six months thereafter. “Hybrid” indicates the loan mixes a fixed-rate initial period with a variable-rate later period.
Core definitions
– Adjustable-rate mortgage (ARM): a home loan whose interest rate can change after an initial fixed period. Changes are tied to a published benchmark (index) plus a fixed percentage (margin).
– Index: a market rate that moves independently of the lender. Common examples are the prime rate or a Constant Maturity Treasury (CMT) yield.
– Margin: a fixed number of percentage points the lender adds to the index to set your adjustable rate.
– Caps: contractual limits on how much your interest rate (or payment) can increase at each adjustment and over the life of the loan.
– Adjustment frequency: how often the rate resets once the adjustable period begins — for a 5/6 ARM that’s every six months after year five.
How it works (step by step)
1. Origination: You borrow for a stated term (commonly 30 years). For the first five years you pay an interest rate that does not change.
2. Transition: After five years the lender re-prices the loan every six months.
3. New rate calculation each reset: New rate = current value of the index + lender’s margin.
4. Payment re‑calculation: At each reset the monthly payment is recalculated using the outstanding principal, the new rate, and the remaining loan term (unless the loan has a separate payment cap or interest-only option).
5. Protections: The loan agreement should specify periodic caps (limit per six-month change) and lifetime caps (limit over the entire loan).
Advantages
– Lower initial rate: The fixed five-year rate is typically below current rates on comparable fixed-rate loans, producing lower early payments.
– Short‑term cost savings: Could be advantageous if you plan to sell or refinance within the fixed period.
– Flexibility: If rates fall, your interest rate can adjust downward after year five.
Disadvantages and risks
– Rate risk: After five years your rate can increase every six months. That can raise payments substantially.
– Payment shock: Frequent resets (every six months) mean faster exposure to rising rates compared with ARMs that adjust annually.
– Complexity: You must understand index, margin, caps, reset dates, and whether the payment is fully amortizing after each reset.
– Potential prepayment penalties: Some loans impose fees if you refinance or pay off early—ask the lender.
How the adjustable rate is determined
At each reset the lender looks at:
– The chosen index value at the specified look-back date.
– The loan margin.
The resulting “fully indexed rate” = index + margin. The lender then applies the contractual caps to ensure the new rate doesn’t exceed the allowed change.
Do caps prevent rates from getting too high?
Yes, caps are the main consumer protection in ARMs. Typical cap structure:
– An initial cap on the first adjustment (e.g., 2 percentage points above the start rate).
– A periodic cap (e.g., 1% every adjustment).
– A lifetime cap (e.g., 5% above the initial rate).
Read your promissory note to confirm exact cap amounts.
Checklist: what to ask and confirm with a lender
– What index is used (prime, CMT, LIBOR alternatives, etc.)?
– What is the lender’s margin?
– What is the initial fixed interest rate and start date for adjustments?
– How often does the rate adjust after year five? (Should be every six months.)
– What are the caps? (initial, periodic, lifetime)
– Will my monthly payment fully amortize the loan after each reset?
– Is there a prepayment penalty? If so, how much and how long does it apply?
– Is the loan convertible to a fixed rate, and at what cost?
– Who pays required fees (e.g., rate lock, appraisal, origination)?
Worked numeric example
Assumptions:
– Loan amount: $300,000
– Term: 30 years (360 months)
– Initial fixed rate (years 0–5): 3.50% annual
– After five years, index = 4.00%, lender margin = 3.00% → fully indexed rate = 7.00%
– Adjustments occur every six months after year five
Step 1 — monthly payment during fixed period:
– Monthly rate = 3.50% / 12 = 0.29167%
– Monthly payment ≈ $1,347 (fully amortizing over 30 years)
Step 2 — remaining balance after 5 years (60 payments):
– Remaining principal ≈ $269,055
Step 3 — payment after the rate resets to 7.00% (remaining term = 25 years = 300 months):
– New monthly rate = 7.00% / 12 = 0.58333%
– New monthly payment ≈ $1,901
Result: Monthly payment increases by roughly $554 after the reset (from ≈$1,347 to ≈$1,901), illustrating potential payment shock. Actual numbers will vary by lender, exact payment formula, and whether caps alter the reset amount.
Comparisons: 5/6 ARM vs. fixed-rate mortgage
– Predictability: Fixed-rate mortgage payments never change; a 5/6 ARM’s payments can change every six months after year five.
– Up-front cost: 5/6 ARMs typically offer a lower initial rate than fixed-rate loans.
– Suitability: A 5/6 ARM may suit borrowers expecting to move or refinance within the fixed period. It is riskier for long-term holders who cannot tolerate variable payments.
Practical tips
– Run a “worst-case” scenario using the loan’s lifetime cap to see the maximum possible payment.
– Ask for a sample amortization schedule showing payments and balances at resets.
– Confirm if the loan uses a look-back period for the index and how payment adjustments are calculated.
– Shop multiple lenders and compare fully indexed rates and cap structures, not just the initial teaser rate.
Reputable sources
– Investopedia — “5/6 Hybrid ARM” (article overview and definitions)
https://www.investopedia.com/terms/1/5-6_hybrid_arm.asp
– Consumer Financial Protection Bureau (CFPB) — Consumer Handbook on Adjustable‑Rate Mortgages
https://www.consumerfinance.gov/consumer-tools/mortgages/resources/adjustable-rate-mortgages/
– Freddie Mac — “What is an ARM?”
https://www.freddiemac.com/learn/what-is-an-arm
Educational disclaimer
This explainer is for educational purposes only and does not constitute personalized financial, legal, or tax advice. Mortgage terms, examples, and calculations are illustrative; consult a licensed mortgage professional and read loan documents carefully before making any borrowing decision.