Five Year Mortgages: How Do They Work In Detail?

Yes, they do exist. They’re not so common, but they are available out there. What we’re going to do is to talk about the two types of five year mortgages that are available in the market. 

1. The first one is what is known as an ARM.

ARM stands for Adjustable Rate Mortgage.

In essence, most ARMs typically range for 30 years. If you got a mortgage you will see something as a five-year fix then ARM. What that means is that the mortgage will have a fixed interest rate for five years. Then every six months or every year after that, the interest rate on that mortgage is going to basically fluctuate depending on how the market is going.

If the Fed announces that the rates are going to go up then within the next six months or a year, the rates are going to go up. Then afterwards, if they announce that the rates are going to go down, then it just continues to go up and down. Typically, for these types of mortgages, there’s going to be what they call a ceiling. Meaning there’s a maximum amount of interest that a bank can charge, and that will be the very top and then there’s a bottom portion of it. 

What makes this a five year mortgage is that you will find that the rates are going to be fixed within the next five years. Then at the end of the five years, you can choose to either stay in that mortgage and ride along with the ups and downs or just simply get out of that mortgage and maybe refinance it for another five-year mortgage or another mortgage that it is in fact fixed for the remaining 30 years, or you can just refinance it.

2. The second type of a five-year mortgage is one that literally lasts five years. 

This mortgage will be divided into 60 payments in total. The first 59 payments will be for a certain amount. Let’s say you have a five-year mortgage, and for the first 59 payments, it will be $1,000 a month. That will be your mortgage every single month. Then at payment 60 you’re going to have what they call a balloon payment.

The terminology is pretty self-explanatory, it’s a balloon because we’re talking about something that’s big and all blown up, and so it is a blown-up payment. Meaning it’s a large sum of money that you’re going to have to pay towards the end. 

The balloon payment could be something like $75,000, just as an example. Let’s suppose we have a mortgage for $100,000. Then, for the first 59 payments, you’re going to pay $1,000, and then towards payment 60, you’re going to have to figure out a way to come up with the remaining $75,000. Some people choose to just simply refinance out of it. They take the remaining $75,000 that they owe, and they can just sign up for a new 5 year mortgage, or they can sign up for a 15 year mortgage, or they can do it for a 30 year mortgage, or some people figure out a way to just pay it off.

Meaning they have a total of five years. They’ve been paying $1,000, but there’s always a plan to finish paying it off. One option will be to use credit cards at 0% APR and use a couple of them to come up with $75,000. You can use personal loans to pay it off, but personal loans are usually over 20% in terms of interest rates versus a mortgage, which depending on your FICO and depending on what interest rates are available in the market, it could range somewhere between that percentage.

The other option will just simply be to refinance to a new loan. Now, you might be wondering why do banks offer something like that? There are tons of different banks out there in the market. Then each one of those banks are regulated by different entities. 

Some of them have more flexible roles than others, and typically the type of banks that offer five-year mortgages are those banks who are the smaller banks, the community banks, the credit union banks who have more flexibility in terms of creating the different type of mortgages that they can sell to the public.

Five-year mortgages: What banks are looking for 

They are looking for a faster turnaround. Instead of being married to you for the next 30 years or so, they want to do it for 5 years because that will give them the option to get access to the money faster. 

Every five years, they get to change clients, they get to settle the mortgage, and they take that money that you pay them off and issue that money to someone else and then charge them again on origination fees or take advantage of the changes in the market and maybe charge a higher interest rate.

five year mortgage in the USA
Five-year mortgages are available in some banks, and there are several reasons for this

That’s why banks get to do that because at the end of the day there’s always a product available for every type of different consumer. We all have different needs. Some people are comfortable having a 30-year mortgage because they don’t envision themselves living anywhere else. They bought a home. 

They want to grow older. They want to have their kids there. They want to have a family there. They have no problem being married to the bank for the remaining 30 years, but other consumers like real estate investors they just want to be in and out.

Maybe they just want to buy a house. They want to rent that out for a couple of years, and gain some equity out of it. They want to cash out and refinance out of it, and they just use that money and then buy something bigger. Some people are just simply flippers. They want to be able to get access to capital so that they can buy a house so that they can fix it up and make it look pretty. 

That way they force the appreciation out of that house, and then they sell it and they just pocket the gains, and they just get rid of the mortgage.

Playing around with the interest rate – Five-year mortgage

Another reason why people will actually want to leverage this type of product is because they are playing around with the interest rate. Let’s say, for example, you anticipate that the interest rates after year five, they’re going to start going down, for sure. 

You know that, and you don’t want to lock a rate for 30 years because it will be a lot preferable for you to be able to get that mortgage in year six or seven or eight. What happens with this is that the property that you want to invest in, it’s sitting in front of you right now. You don’t want to wait for year six. You don’t want to wait for seven or eight years because you’re going to lose that house. The seller wants to sell it today.

The seller is not going to sit around and wait for you to get to your six or seven and eight, just so you can get a good interest rate. What a lot of people do is that they lock themselves into a nice mortgage, and they want to take advantage of this low monthly payment of $1,000. 

If the Fed does announce that the rates are going to go down, what they do is that they just simply refinance out of this mortgage. Then they can lock themselves into another five year mortgage, or another 30 year mortgage, or something to that matter. 

A lot of people do that just so that they can save more on the interest rates, they can save more money in the long-term. If nothing happens, within year 3, so to speak, then you just simply wait until year 5, and then you make your 59 payments for $1,000. Then at payment 60, then you get to figure out what you want to do.

The options are just simply applying the options that are already discussed, whether it’s with a credit card at 0% APR, with a personal loan, or perhaps another refinance

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