Those who are long time mortgage brokers report clients being confused by various mortgage terms. In order to understand what a 5/1 Jumbo ARM is, one must first understand the terms individually and then see how they work together. Here are some brief explanations of the terms that must be clarified:
5/1 – According to the Federal Reserve, a loan that is quoted as a 5/1 is called a hybrid mortgage. These types of loans combine a fixed rate for a specific period of time (in this case a five year period) and then is subject to a change in rate on a specific basis (in this case, each year).
ARM – More commonly known as an adjustable rate mortgage. According to Freddie Mac, these loans are popular because they typically offer the home buyer an opportunity for a lower starting interest rate allowing some to qualify for a mortgage with more ease;
Jumbo loan – According to Investopedia, jumbo loans are defined as “….not eligible to be purchased, guaranteed or securitized by Fannie Mae or Freddie Mac….” For many investors, this may mean the loans are more risky than traditional mortgage loans. As of 2011, Fannie Mae conforming loans are loans that are less than $417,000 (except as provided for high cost areas) for a single family home. These limits are subject to change.
Defining a 5/1 Jumbo ARM
Based on the information that is contained in the definitions above, a 5/1 Jumbo ARM loan is an adjustable rate loan, in an amount in excess of $417,000 (except in certain geographical areas where they may be as high as $938,000). For the first five years of the loan, the interest rate is fixed. After the five years have expired, the interest rate is subject to adjustment on an annual basis unless the loan is converted to a fixed rate loan or paid in full.
Understanding the terminology
Adjustable rate mortgage loans come in several forms. The 5/1 is a hybrid loan because it offers the distinct combination of a fixed rate for a specific period of time then converts beginning the sixth year to a fully adjustable mortgage. In the case of a 5/1 loan, the rate may change annually after the fifth year. Jumbo loans are “non-conforming” loans generally used for high-value homes. In some cases, these loans are popular with both first time home buyers and for real estate investors.
Summary
There are numerous risks that are associated with adjustable rate mortgages of all types. Many mortgage lenders have pre-payment penalty clauses in their mortgage agreements to ensure that they can continue to reap the rewards of high value loans. Before a borrower accepts the terms of a 5/1 adjustable rate mortgage, the mortgage terms should be carefully reviewed. Adjustable rate mortgages are typically tied to either prime rate or to the LIBOR (London Interbank Overnight Rate). Changes in these indexes can cause interest rate spikes in a mortgage and create financial challenges for a homeowner.