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A Guide to Home Loans for Bad Credit

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Home Loans For Bad Credit

It may not come as a surprise that buying a home can be challenging for people who have bad credit, especially with the new median credit score required to qualify for a new mortgage slowly rising. Lenders like to see high credit scores because it exhibits the borrower’s ability to manage debt, make on-time payments and use their credit responsibly. Even though these things will come into question when a person with poor or bad credit applies for a home loan, they don’t have to let their score hold them back from homeownership.

This guide will review how bad credit can affect your ability to get approved for a home loan, available home loan options for bad credit and tips for improving your score.

PART I: Home Loan Options For Borrowers with Bad Credit

Conventional Loans for Bad Credit

 Credit Score RequiredDown payment RequiredMortgage InsuranceFees/Fine Print
FHA loans5803.5% (10% for buyers with a credit score less than 580)
RequiredUpfront mortgage insurance
Fannie Mae HomeReady®

3%Required, but can be canceled once borrower’s home equity reaches 20%
Homeownership education: $75
USDA loansNo minimum credit score0%
Origination: 1-2%; Guarantee fee: 1%; Annual fee: .35%
VA loansNo minimum credit score
0%, unless specified by lender
Not requiredFunding fee varies

FHA loans

Homebuyers turn to government-backed Federal Housing Authority (FHA) loans for many reasons, particularly the low down payment and acceptance of applicants with a low credit score. There is no minimum income requirement, but lenders do want to see that the borrower can afford his or her monthly mortgage payments, if approved.

FHA loan requirements include:

  • A minimum credit score of 580
  • The property must be buyer’s primary residence
  • The property must meet standards outlined by the U.S. Department of Housing and Urban Development (HUD)
  • A down payment of 3.5%; 10% if credit score is lower than 580

If an FHA loan seems like the best option for you, the lender tool on the HUD website can help you find an FHA-approved lender.

VA loans

VA loans carry more relaxed requirements than conventional loans. Backed by the U.S. Department of Veterans Affairs, VA loans are offered to active-duty service members, veterans and their spouses who wish to purchase a condominium, a single-family home, a co-op or a manufactured home. What makes this a great choice for those with bad credit is that there is no minimum credit score or down payment required, unless specified by the lender.

VA loan requirements include:

  • A certificate of Eligibility (COE) to confirm that the buyer is a veteran or an active duty service member
  • The property must be buyer’s primary residence
  • A debt-to-income ratio (DTI) of no more than 41%

Buyers can can contact lenders directly to determine if a VA loan is an available option.

USDA loans

Created by the U.S. Department of Agriculture, USDA loans can be used to purchased property in areas defined as suburban or rural areas across the country. This option is often considered by those who will likely be denied traditional financing because of their low credit score and income. When applying for the USDA loan, applicants are not required to make a down payment, can have closing costs included in the loan and may not be required to have a minimum credit score, unless specified by the lender.

USDA loan requirements include:

  • The property must be the buyer’s primary residence
  • Positive payment history on accounts
  • A very low to moderate income
  • The property must be located in a USDA-eligible area
  • A reliable, verifiable source of income for at least the last 24 months

To find a lender who offers USDA loans, borrowers can review the recent list of approved USDA lenders or contact a specific lender directly to see if it offers this type of loan.

Fannie Mae HomeReady® program

The Fannie Mae HomeReady program is an option for first-time homebuyers as well as repeat buyers. The low down payment of 3%, which can be paid for using grants, a gift, cash-on-hand and Community Seconds® (a subordinate mortgage used in connection with a first mortgage delivered to Fannie Mae), cancellable mortgage insurance and acceptance of low credit scores make this an option to consider.

Fannie Mae HomeReady requirements include:

  • A credit score of 620 or greater
  • A low to moderate income
  • Completion of homeownership education
  • The home must be located in a low-income Census tract area

Buyers can speak to specific lenders to determine if they offer the Fannie Mae HomeReady loan.

Manufactured Home Loans For Bad Credit

Manufactured homes are built in factories then transported to a site where they are permanently affixed to a chassis. Many people who are interested in purchasing this particular type of home turn to financing to cover the cost, whether it is through a bank, credit union or the manufactured-home retailer.

As with purchasing a traditional residential property, those with bad credit have a reduced chance of getting approved for a manufactured-home loan, but there are options that are available to them.

 Credit Score Required
Down payment Required
Mortgage Insurance
Fees/Fine Print
FHA Title I
No minimum credit score
5% (10% if credit score is 500 or lower)
FHA Title II5803.5% (10% if credit score is 580 or lower)
Chattel Loans
Varies based on lender
Varies based on lender, but 5% is common
Varies based on lender
Fannie Mae HomeReady program
6203%Required until buyer’s home equity reaches 20%
Homeownership education: $75
USDA loansNo minimum credit score
Not requiredRequiredOrigination: 1-2%; Guarantee fee: 1%; Annual fee: .35%
VA loans
No minimum credit score
Not required, unless specified by lender
Not required
Funding fee varies


FHA loans can be used not just to purchase a manufactured home, but also the lot where the manufactured home will be located. When opting for this type of financing, there is a maximum loan amount that varies based on what you are purchasing. For example, if you are only buying a manufactured home, the loan maximum is $69,678, but if you are purchasing the home and the lot, the loan maximum is $92,904. If a buyer does not wish to purchase a lot, he or she can lease, but the lender must have an initial lease term of three years.

FHA loan requirements for the purchase of a manufactured home include:

  • The ability to cover the minimum down payment
  • The home must be used as the primary residence
  • The home’s site must meet local standards
  • Sufficient monthly income to cover cost of the mortgage
  • The home must meet the Model Manufactured Home Installation Standards.

Local manufactured-home retailers can provide borrowers with a list of lenders that offer FHA loans, or they can use the lender tool available on the HUD website.


VA loans are always a great option for veterans and active duty service members who don’t have the best credit or the cash to cover a down payment. If you plan to purchase a manufactured home using a VA loan, you will encounter similar eligibility requirements as those who opt for traditional residential properties, as well as a few additional requirements.

VA loan requirements for the purchase of a manufactured home include:

  • A certificate of Eligibility (COE) from the military
  • Payment of a VA funding fee
  • The home must be affixed to a permanent foundation
  • The home must be considered real estate, rather than personal property


Conventional loans can be used to purchase manufactured homes that will be the buyer’s primary residence or second home. The home will be used as collateral for the borrower to secure the loan, and a down payment of at least 5% is often required.

Conventional loan requirements for the purchase of a manufactured home include:

  • The buyer must own the land where the home is located
  • The home cannot have been built on or before June 15, 1976
  • The home should be at least 12 feet wide, with no fewer than 600 square feet of living space
  • The home must be connected to utilities


USDA loans can be used for the purchase of a manufactured home as well as the lot where the home will be located. Although the home is manufactured, the buyer is still expected to live in a rural area, just as those who choose to purchase a site-built home using this type of loan are.

USDA loan requirements for a manufactured home include:

  • The home must be affixed to a permanent foundation
  • Must purchase a site that is located in a rural area
  • The site must have both adequate water and sewage systems
  • If considered a single-wide, the manufactured unit must be at least 12 feet wide, with no fewer than 400 square feet of living space
  • If considered a double-wide, the manufactured unit must be at least 20 feet wide, with no fewer than 400 square feet of living space

PART II: Ways to Clean Up Bad Credit Before Applying for a Home Loan

With your credit score heavily affecting the total cost of your loan, you’ll want to clean up your bad credit before you apply for any type of home loan. By taking several steps, you won’t just boost it, you’ll save money, too. For example, if you can increase your credit score from the 620-639 range to somewhere between 640 and 659, you can lower your APR by nearly half a percentage point and save around $70 monthly on your mortgage payments.

Tips to improve your credit score

A low credit score can hold you back from getting a home loan, but you don’t have to be stuck with your current score. If you want to improve your credit score before applying for a home loan to increase your chances of approval, there a few different things you can do.

  • Pay down existing debts: Your credit score can drop or rise based on how much debt you currently have and when you make payments. As you pay down your debt, you will increase your score.
  • Pay your bills on time: Payment history is a major part of determining your credit score, so paying your bills on time can mean a score increase.
  • Avoid applying for new credit: Applying for new credit will result in a hard inquiry on your credit report, which can cause your score to drop.
  • Keep old credit accounts open: Keep old accounts open because closing one will shorten the length of your credit history and bring down your score.
  • Address discrepancies on your credit report: It is not unheard of for people to discover inaccurate information on their credit reports, so a thorough review of your report could help you correct any discrepancies that may be bringing down your score.

Getting a mortgage after bankruptcy or foreclosure

Bankruptcy has its benefits, but when a person files, his or her credit score is likely to drop. Even after their bankruptcy has been “discharged,” releasing the debtor of his or her responsibility for the debts, the filer can expect it to remain on his or her credit report for at least seven years, and possibly up to 10.

If you have a bankruptcy filing on your credit report, before applying for a mortgage it might be better to wait until it is removed from your report and work on increasing your score in the meantime, but this not always what people decide to do.

If you choose to apply for a loan before your bankruptcy has been removed from your report, conventional loans and government-backed loans are still an option. You may have to wait a specified amount of time after the bankruptcy has been discharged, which varies based on the type of bankruptcy filed and the type of loan you plan to secure.

For example, someone who has filed a Chapter 7 liquidation will have to wait four years if he or she wants to apply for a conventional home loan. Someone who has filed for Chapter 13 will have to wait one year if he or she wants to apply for an FHA loan. If foreclosure is the cause of the bankruptcy, this can extend the waiting period. However, if the bankruptcy was due to an extenuating circumstance, such as divorce, illness or job loss, buyers may be able to get the waiting period shortened and find a lender that will work with them.

Improve your shot at approval even if you have bad credit

If your credit score is poor and you still wish to apply for a loan, there are things you can do to improve your shot at approval.

  • Put down a bigger down payment: A bigger down payment means you’ll have to borrow less money for the purchase of your home, and with a smaller loan amount, you might get approved.
  • Explain your low credit score: Certain information that appears on your credit report that drags down your score, such as a missed payment that your creditor reported, can be explained or disputed by adding a statement to your report that lenders can see when they pull your credit report.
  • Get your rent payments reported to credit bureaus: Your rent is a monthly bill that can be reported to the credit bureaus and increase your credit score, but this can only help if you have a positive payment history.
  • Decrease the loan amount: Someone with bad credit may have trouble getting approved for a $200,000 loan because it may appear to a lender that he or she can’t afford the monthly mortgage payments due to heavy debt, but if the borrower finds a less expensive home and applies for a loan for $100,000, he or she will be seen as less of a risk to the lender.

PART III: Additional resources

Renting vs. Buying

People often question whether renting or buying is the better option. When making this decision, you’ll want to look at things like your credit score, annual income and monthly expenses to determine which option is the most affordable for you at the current time. Although there are many factors to consider when deciding if you should rent or buy, if you have poor credit, continuing to rent may be the smartest move because it will give you more time to increase your score as well as your chances of getting approved for a home loan.

Watch out for scams that target low-credit homebuyers

When people are desperate to become homeowners, they can easily fall victim to scams, specifically email phishing. For many years, homebuyers have been targeted by fraudsters pretending to be their real estate or settlement agent in order to get the buyer to pay them money that was meant for their closing costs. Buyers receive an email informing them of a change that affects their closing process and how they must pay closing costs. It states that the buyer must wire the funds rather than pay closing costs using a check, but if the money is sent, the fraudster receives the cash, not the correct party.

To avoid this scam, potential homebuyers should not send any personal information or money. They should ensure they have a clear understanding of their lender’s closing process, call their real estate or settlement agent after they receive an email regarding any changes to the closing process, and request the assistance of their bank with confirming ownership of the account where they have been instructed to wire the funds.

Email phishing is not the only scam homebuyers may encounter. Some people opt for a lease-to-own homebuying experience, but this is known to lead to trouble. Often used to take advantage of low-income buyers, a lease-to-own agreement is a way for property owners to profit from the buyer’s inability to cover the cost of repairs for the home. This particular type of agreement leaves buyers unprotected, so instead of being able to get current with payments after they have fallen behind, like a buyer who has a home loan, one missed payment can result in foreclosure. Ultimately, when the home is foreclosed on, the seller is able to collect the rent and any deposits the buyer made while they lived in the home.

To avoid this scam, homebuyers should consider screening the property owner, speaking to an attorney about the agreement and getting a home inspection to reveal any repairs and their extent, which can help them to determine if they can cover the cost of repairs as well as their monthly rent.


Yes, but buyers cannot apply for a home loan until the waiting period has lapsed.

Yes, but when refinancing, lenders will review your credit score, so if it has improved since you first applied for your bad credit home loan, you may get a better interest rate and lower monthly payment.

Yes, when applying for a home loan, borrowers can choose to have a cosigner who will be responsible for their debt should they be unable to make their monthly mortgage payments.

No, checking your credit will not cause your score to drop because it is not considered a hard inquiry, which is what can lead to a drop in score.

When one lender has denied your loan application because of a poor credit score, you can apply for a home loan with a different lender, but this can bring down your score because each application will result in a hard inquiry on your credit report. That being said, FICO considers all credit inquiries made within a 45-day period to be only one inquiry, so it may be worth it to shop around and then make a decision based on who you think is most likely to approve your application.

Because credit scores range between 300 and 850, lenders often consider a score of 580 or lower poor or bad.

Homebuyers interested in lowering their interest rate may be offered the opportunity to purchase discount points at closing. This prepaid interest allows people to make a payment — one point is 1% of their loan amount — in exchange for the lender lowering their interest rate by a set percentage amount for every point purchased.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kristina Byas
Kristina Byas |

Kristina Byas is a writer at MagnifyMoney. You can email Kristina here


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7 Reasons Your Mortgage Application Was Denied

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Rejection isn’t fun under any circumstances, but it can be especially frustrating when you’re trying to buy a home. If your mortgage application was denied, know that you aren’t alone. Nearly 11% of mortgage applications were denied in 2017, according to the latest available data from the Consumer Financial Protection Bureau (CFPB).

Reasons for a mortgage application denial usually fall into a handful of categories, including credit history, employment history or property issues. Regardless of what the problem is, you’ll walk away from the experience learning why you’ve been denied and can use that information to work toward a favorable outcome in the future.

Below are seven of the most common reasons your mortgage application might not be approved, according to the CFPB — and then how to move forward.

1. You have a history of late payments

Before you can be approved for a mortgage, your lender needs to make sure you’d be able to repay the loan. Your income and how well you manage your existing debt help determine whether you’ll satisfy your mortgage payments every month, but so will your payment history. Failing to pay your electric, internet or other recurring bills on time will eventually affect your credit reports and scores.

Why this matters

Your payment history makes up the largest chunk of your credit score — 35% — and is listed on every debt-related account included on your credit report. Your credit score factors in the following details about late or missed payments, according to the FICO credit scoring system:

  • How late you were
  • How much you owe
  • How recently you were late
  • How many late or missed payments you have

Other negative information such as a bankruptcy or an account in collections are also factored into your score and will catch your lender’s attention.
If you have a credit history filled with late payments, this indicates to your lender that you struggle with maintaining on-time payments and are more likely to continue making late payments while repaying a mortgage.

How to avoid this issue: Maintain a track record of on-time payments for all your existing debt before and after you apply for a mortgage. If you have a few late payments on your credit report, keep in mind the further removed you are from your late payments, the less impact they’ll have on your credit score.

2. Your job status has changed

Rapidly switching employers and being in-between jobs can be grounds for an application denial.

Why this matters

Mortgage lenders like to see evidence of steady employment, especially for the last two years. They’ll usually verify this by reviewing your pay stubs and W-2s. If your employment history is spotty and doesn’t demonstrate that you’ve been maintaining consistent employment, you’re considered a higher risk and likely won’t be approved.

How to avoid this issue: Limit your job changes before you apply for a mortgage. A good rule of thumb is have had no more than three employers in the last two years and no time between those jobs where you were unemployed. Additionally, avoid any job changes after applying for a mortgage, as this could derail the process.

3. Your bank account has some red flags

Lenders will request at least the last few months of statements from your banking institution to see how your finances are holding up. Because they’re closely reviewing those documents, any suspicious-looking activity will present some red flags. Suspicious activity might include, but isn’t limited to:

  • Using multiple P.O. boxes or frequently changing addresses.
  • Conducting wire transfers to and from places known for their tax haven status or terrorism affiliation.
  • Making large cash payments from sources that typically aren’t associated with cash-based transactions.
  • Using money orders that are sequentially numbered.

Why this matters

Combing through your financial profile is part of the mortgage lending process. If you frequently overdraft your checking account, that won’t reflect well on your reputation as a prospective borrower. On the other end of the spectrum, having large deposits that aren’t accounted for can also cause problems.

You’ll need to verify every income source you want counted as part of your application, said Bruce McClary, vice president of communications for the National Foundation for Credit Counseling in Washington, D.C. Any side hustles you have need to be documented and verified if you want that information factored into your ability to afford the mortgage. One way to verify income is by providing your lender with pay stubs or W-2s from your supplemental income sources.

“If you’re relying on every penny, that can really be a roadblock,” McClary said.

How to avoid this issue: Keep track of all your income-related documents and provide them to your lender when they’re requested.

4. You omitted information on your application

Don’t try to outsmart your mortgage lender by withholding information that is pertinent to your loan application, such as neglecting to mention alimony payments or an unpaid federal tax debt. And even if you do so unintentionally, it might be too late to correct it once it’s discovered.

Why this matters

Your loan officer should carefully review your application to make sure it’s filled out completely and accurately. A small error like missing a zero on your income or accidentally skipping a section could mean losing your dream home.

There’s also the chance you forgot to include information that the underwriter caught later in the more extensive screening process, such as money owed to the IRS.

How to avoid this issue: Disclose all of your debt, judgments and other financial-related details to your loan officer upfront. Otherwise, they may not be able to help you if it comes up and disqualifies you later on.

5. You recently opened a new credit account

One of the main ways homebuyers can self-sabotage their chances at being fully approved for a home loan is by making decisions — such as opening a new credit card or financing a new vehicle — that affect their credit profile, after getting an initial green light from their lender in the form of a mortgage preapproval.

A preapproval is conditional and based on where your credit reports, credit scores, income and overall financial picture stand at the time the preapproval was granted. Any changes you make to your finances can prevent you from buying a home.

Why this matters

When you add a new set of debt to your plate, that increases your debt-to-income (DTI) ratio. Your DTI ratio is the percentage of your gross monthly income that is used to repay debt. In most cases, mortgage lenders like to see a DTI ratio of 43% or less. Adding any type of credit account will jeopardize your DTI ratio and potentially push you into denial territory.
“Everybody focuses so much on the credit report, but the other question is: Are you financing a home that you can actually afford?” McClary said.

How to avoid this issue: Don’t make any financial decisions that will result in an inquiry on your credit reports and an increase in your debt load. Practice this for 6-12 months before you start the homebuying process, McClary advised. You’ll also need to continue this practice until after you get your house keys. Additionally, try to find ways to boost your income to pay off debt.

6. You don’t have enough cash to close

Borrowing a mortgage will cost you more than just your monthly mortgage payment. In most cases, you’ll have a required down payment and closing costs to pay for. If you don’t have proof that you can cover those costs, your application may be rejected.

Why this matters

Your mortgage lender will want you to have some skin in the game for your home purchase, which would be your down payment. There are also the closing costs you’ll be charged for taking out a mortgage.

During the approval process, your lender will request that you provide proof of funds to close on your loan. Some examples of proof include bank statements, retirement account statements and gift letters with the donor’s proof of funds — in cases when a loved one is helping you meet your “cash to close” amount. Be sure your gift money is coming from an acceptable source, however.

Failing to provide the necessary documents can lead to a mortgage denial.

How to avoid this issue: Save aggressively for your down payment and closing costs. It’s possible to qualify for a mortgage with as little as 3% down, depending on your credit score. Your closing costs can range from 2% to 5% of your home’s purchase price.

If you’re borrowing or withdrawing from a retirement account, supply documentation from your plan provider that shows you qualify to do so, along with statements that verify you have the funds available to use for your home purchase. And if you need some extra help, consider a down payment assistance program.

7. Your home appraisal doesn’t match up

Getting a full mortgage approval is also contingent upon having the home appraised. Any problems that come up during the appraisal process can stop you from getting your house keys.

Why this matters

A home appraisal is an unbiased estimate of a home’s value. Your mortgage lender will more than likely require an appraisal for the home you’re trying to buy in order to verify that the purchase price checks out. If the appraisal aligns with the sales price or is slightly higher, no worries there. But if the appraisal is lower than the sales price, your lender might deny your application.

How to avoid this issue: If you have the financial capacity to do so, you can make up the difference in cash. You could also try negotiating a lower sales price with the home seller.

How to move forward after a mortgage denial

Once you’ve been denied, it’s time to figure out how to work toward eventually getting approved. Keep these tips in mind on how to move forward.

  • Find out why you were denied. Mortgage lenders are required to give you an explanation for why they denied your mortgage application if you submit a request for that information in writing, according to the CFPB. They must also provide you with a copy of the credit report that factored into your denial.
  • Improve your circumstances. Whether it’s a high DTI ratio, too short of an employment history or another common setback, take some time to correct those issues and better position yourself for mortgage approval in the future.
  • Consider housing counseling. In cases where you were denied for credit or income-related reasons, McClary suggests reaching out to a nonprofit housing counseling agency for help addressing those issues.

Everyone’s timeline is different for when they should apply again, so be sure to check with your lender or a housing counselor for guidance on next steps.

The bottom line

Being denied for a mortgage can be a discouraging experience, but it doesn’t mean all hope is lost for your goal of homeownership.

Once you’re clear on why you were denied, you can make the necessary changes so you’re not rejected the next time around.

“The more you do leading up to the loan application to make sure that you check and double-check every step, then the easier the actual homebuying process will be,” McClary said, “because that financing piece is locked down and you’ve addressed all the issues that could potentially be roadblocks.”

Here’s what you need to know about the most important factors to getting approved for a mortgage.

This article contains links to LendingTree, our parent company.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Crissinda Ponder
Crissinda Ponder |

Crissinda Ponder is a writer at MagnifyMoney. You can email Crissinda here

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The 5/1 ARM: What Is It and Is It for Me?

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

5/1 ARM mortgage

Homebuying involves a lot of decisions. You choose your neighborhood, your home, your mortgage program and your down payment. But you’ll also need to decide on the structure of your interest rate — fixed or adjustable.

While most people prefer a fixed-rate mortgage, there is a market for adjustable-rate loans. Nearly 7% of all loans originated in April 2019 were adjustable-rate mortgages, according to Ellie Mae’s latest Origination Insight Report.

One common adjustable-rate mortgage is known as a 5/1 ARM. It has an initial fixed rate for five years before the interest rate starts adjusting. The rate can change every year for the remaining life of the loan.

An adjustable-rate mortgage can be a good way to get a better initial interest rate, usually lower than a traditional 30-year fixed-rate loan. But before you dive in to an adjustable-rate mortgage application, you’d better know how the changing interest rate will affect what you pay.

Here’s a guide to how 5/1 ARMs work, how they differ from fixed-rate mortgages and their pros and cons.

What’s a 5/1 ARM?

Before defining a 5/1 ARM, we should first define an adjustable-rate mortgage, or ARM. An ARM is a type of mortgage that has an interest rate that changes, or adjusts, multiple times over the life of the loan.

Different types of adjustable-rate mortgages have interest rates that change at different intervals and are limited to certain levels of increase each time. Most ARMs start out with a fixed interest rate for several years and eventually transition to a period with an variable interest rate for the rest of the term, usually a total of 30 years.

In the case of a 5/1 ARM, the mortgage rate is fixed for the first five years. That’s what the “5” refers to. Then, the mortgage can adjust each year thereafter for the remaining 25 years of the loan term. That’s what the “1” refers to, since the rate changes after one year.

Since the 5/1 ARM is a blend of a fixed-rate and adjustable-rate loan, it can also be known as a hybrid mortgage.

How 5/1 ARM interest rates adjust

Adjustable-rate mortgages are less predictable than fixed-rate loans and are directly impacted by economic factors after you’ve started repaying the loan.

Changes to the interest rate on an adjustable-rate mortgage are based on an index, which is a benchmark interest rate that reflects general market conditions, according to the Consumer Financial Protection Bureau. The most common index used for mortgages is the one-year London Inter-Bank Offer Rate, or LIBOR for short.

Mortgage lenders use the index and then add on a fixed margin to determine your interest rate. A margin is a set number of percentage points added on to the index. So, if the one-year LIBOR is 2.65% and your lender’s margin is 2.15%, your mortgage rate, or “fully indexed rate,” at that time would be 4.8%.

Interest rates on 5/1 ARMs typically start out lower than those for fixed-rate mortgages. As of mid-May 2019, the average 30-year fixed-rate mortgage was 4.07%, while the 5/1 ARM was 3.66%, according to Freddie Mac’s Primary Mortgage Market Survey.

Let’s take a look at how a 5/1 ARM stacks up against a 30-year fixed-rate mortgage after the first five years. We’ll use a hypothetical $250,000 house and assume the buyer is putting down 20%, which means they’ll borrow a $200,000 mortgage.


5/1 ARM

30-Year FRM

Interest rate



Monthly payment
(Principal and interest)



Interest paid after five years



Principal paid after five years



As shown above, because the 5/1 ARM has a lower interest rate during its fixed-rate period than the 30-year fixed does, the buyer would pay $767.34 less in interest after five years and pay down $217.37 more of the principal balance of the loan. The results could quickly reverse once the 5/1 ARM’s interest rate begins adjusting, however.

Let’s look at the 5/1 ARM (on a $250,000 home with a $50,000 down payment) after two interest rate adjustments to understand how the changes can impact the monthly mortgage payment.


Adjustment #1

Adjustment #2







Interest rate (Index + margin)



Monthly payment (Principal and interest)



In the above scenarios, the 5/1 ARM interest rate jumps significantly higher than 3.7%. By the time the rate jumps to 4.8% and again to 4.95%, the monthly payment increases by nearly $130 and $150, respectively.

Pros and cons of 5/1 ARM

As with any financial product, there are benefits and drawbacks. Consider the following pros and cons of borrowing a 5/1 adjustable-rate mortgage.


  • ARM interest rates are usually lower than 30-year fixed-rate mortgages (and sometimes 15-year fixed-rate mortgages) for the first five years, which means you’ll pay less in interest during that time.
  • Monthly mortgage payments are also typically lower in the first five years, thanks to the lower interest rate.
  • There is a limit to how high your interest rate can increase over the life of your loan, which is called a lifetime adjustment cap. The cap is typically five percentage points, but your lender’s cap could be higher, according to the CFPB.


  • After the first five years of a 5/1 ARM, the interest rate can adjust each year and is not predictable. Although there’s a cap on how much your rate can increase the first time it adjusts, it can still be significantly higher than the fixed rate you’re losing.
  • Because your interest rate adjusts over the life of your loan, so does your monthly mortgage payment. If a higher mortgage payment would greatly impact your budget, this could cause you some affordability problems.
  • If you want to keep a fixed interest rate, you must refinance into a fixed-rate mortgage, which comes with closing costs and other fees. You must also qualify for a refinance in order to get out of your existing mortgage.

A 5/1 ARM might work for you if …

“For certain people, like first-time homebuyers, 5/1 ARM mortgages are very useful,” said Doug Crouse, a senior loan officer with nearly 20 years of experience in the mortgage industry.

Homebuyers in the following scenarios could benefit from a 5/1 ARM:

  • First-time buyers who plan to move within the first five years of owning their home.
  • Buyers who plan to pay of their mortgage very quickly.
  • Buyers who are borrowing a jumbo mortgage.

Crouse explained that with some first-time buyers, the plan is to move after a few years. This group can benefit from lower interest rates and lower monthly payments during those early years before the fixed rate changes to a variable rate.

Mindy Jensen, a real estate agent and community manager for BiggerPockets, an online community of real estate investors, agrees. “You can actually use a 5/1 ARM to your advantage in certain situations,” she said.

A 5/1 ARM could work well for someone who wants to aggressively pay down a mortgage in a short amount of time, Jensen explained. After all, if you know you’re going to pay off your loan early, why pay more interest to your lender than you have to?

“The lower initial interest rate frees up more money to make higher principal payments,” Jensen said.

Another group of people that can benefit from 5/1 ARM are those who take out or refinance jumbo mortgages, Crouse added.

For these loans, a 5/1 ARM makes the first few years of mortgage payments lower because of the lower interest rate. This, in turn, means that the initial payments will be much more affordable for higher-end properties.

Plus, if buyers purchased these more expensive homes in desirable areas where home prices are projected to rise quickly, it’s possible the value of their home could soar in the first few years while they make lower payments. Then, they can sell after five years and hopefully make a profit.

However, keep in mind that real estate is a risky investment and nothing is guaranteed.

A 5/1 ARM isn’t right for you if …

For homebuyers who plan to stay put for longer than five years, Crouse and Jensen share the sentiment that a 5/1 ARM might not be as beneficial for them.

Homeowners should also consider whether they want to be landlords in the future, Jensen added. If you decide to move out of your home but keep the mortgage and rent out your home, a 5/1 ARM may not serve you.

Additionally, if you think there’s a chance you might not be able to refinance out of a 5/1 ARM by the time your interest rate starts adjusting, you might consider a fixed-rate mortgage instead.

The bottom line

The 5/1 adjustable-rate mortgage can offer you the benefits of a lower interest rate and monthly payment, especially in the first five years of the loan. This alone may make it an attractive product for homebuyers.

Still, you can’t predict how high your interest rate can go when it transitions from fixed to variable, and that’s a budgeting concern you’ll need to consider when weighing your home financing options.

If after reading this guide you think a 5/1 ARM might be right for you, keep this list of questions in mind as you gather mortgage quotes from lenders:

  • How long do I want to live in this house?
  • Will this house suit my family if my family grows?
  • Is there a chance my job will transfer me elsewhere?
  • How often does the rate adjust after five years?
  • When is the adjusted rate applied to the mortgage?
  • If I want to refinance in five years, how much might that cost me?
  • How comfortable am I with the uncertainty of a variable rate?
  • Do I want to rent out my house if I decide to move?

Once you’ve filled in the answers to the above questions, your next step is to understand the minimum mortgage requirements for the available loan programs.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Cat Alford
Cat Alford |

Cat Alford is a writer at MagnifyMoney. You can email Catherine at [email protected]

Crissinda Ponder
Crissinda Ponder |

Crissinda Ponder is a writer at MagnifyMoney. You can email Crissinda here

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