So what happens with an ARM is that your interest rate is fixed in the first X amount of years of the loan - in your situation you being presented with a 5/1 ARM, meaning that the rate is fixed in for the first 5 years of the loan. The "1" in the 5/1 ARM means it'll adjust very 12 months beginning at the end of the 5th year (payment 61).
After the fixed period ends your rate will adjust based on a few factors - the index your ARM is based on, the margin over the index that is added to calculate your "fully indexed interest rate", and the "rate adjustment caps".
With an FHA ARM the common rate adjustment caps are 1% for the first adjustment, 1% every subsequent adjustment, and no more than 5% over your initial rate at any time in the loan. This would be shown as a "1/1/5" cap structure - initial/subsequent/lifetime. This gives FHA an edge over other ARM's as most other ARM's have a 2-5% initial adjustment cap, so if your FHA 5/1 ARM interest rate were to increase on payment 61 then it would only increase a maximum of 1% - if you start at 3% then that is 4% months 61-72, 5% months 73-84, 6% months 85 to 96, 7% months 97 to 108, and 8% months 109 to 120 and never higher than 8%. There is also usually a "floor" interest rate that it can never drop below, often it is the initial rate of the loan or it could be the initial "cap", it can vary depending on lender.
For FHA loans the index is usually based on the weekly average yield on U.S. Treasury Securities, which currently is 0.263. So if your floor rate is 1%, and your margin (the amount added to the index to calculate your "fully indexed interest rate") is 2%, and so your interest rate were to adjust today it'd be 2.263%... the index' right now are EXTREMELY low, I would not anticipate them being this low when your rate would adjust. No one can tell for certain, but my guess is that the indexes will probably be in the 4-5% range in ~5 years from now.
So compare that to what you can get on a 30-year fixed today, let's say it's 4.5%, you would need take the interest you'd pay over the first X amount of years with either mortgage to determine which option would be financially better for you during the time you have the mortgage.
In the above example, using a $135,000 loan amount, the payment goes from $567.17 for the first 5 years, to $633.53 the 1st year of the adjustment, $699.38 the 2nd year of adjustment, $766.35 the 3rd year of adjustment, $834.05 the 4th year of adjustment and let's say you are only looking over a 10 year period so the 5th year of adjustment the payment is $902.18... and after 120 payments you would owe $107,859.69 on the mortgage. That is if interest rates were to increase the maximum per year. If you were to start out with the 4.5% 30-year fixed, your payment would be $684.03 for the life of the loan, after 120 payments you would owe $108,120.04 on the mortgage.
So do you feel comfortable dealing with those potential payment increases at those points in the loan? Do you see your income increasing to be able to handle the higher payment amounts that could come with an ARM? You said you see yourself moving back to San Diego within 5 years... but would you sell then? Rent the property out? How long do you see yourself having this mortgage for?
As a Realtor, I don't think any of us should answer this question!!! You should speak with your lender and have them give you all the terms on paper. You have to make the decision that is right for you once you have been completely informed.
I think Rudy's answer is the only one to listen to... he's a lender!! But I'm curious why you would not talk to the lender you have been pre-qualified through about this. If you want a second opinion, talk to another local lender. I would be happy to direct you to one I do a lot of work with if you are not sure who to call.
If you are certain that you are going to be relocating in 5 years than an Arm could save you money, but there certainly is more of a gamble. If prices do not remain stable and you become underwater on your home, you might not be able to move and you might end up having to refinance into a higher rate loan then what you can get now. The interest rates are very favorable right now for a 30 year fixed loan. It is certainly the safer way to go, and I think if more people played the safety card a few years ago we might not be in as bad of shape today.
However, the 5 year arm might be favorable enough to make it worth the risk. Just be prepared to stay in the home after 5 years or buy your self out by bringing cash to the table if you do need to move. This is certainly worse case scenario, but better to expect the worst and hope for the best when you are talking about a few hundred thousand dollars.
I would also ask yourself if you NEED more home. I am sure that you could get more home, but do you NEED IT? And then my next consideration would be what would the re-sale potential be between the 2 different types of home you could afford based on the 30 yr vs the 5 yr. If the difference is between a condo and a townhouse/singl family then you might want to consider the 5 yr. Historically single family homes and town homes are better re-sale because you have a larger market of buyers that can fit in the home.
In my opinion, speak with your loan officer, speak with your real estate agent, and speak with a family member that knows you and your situation so that you can make an educated decision on what is best for your situation. And then save money in case you need it to sell your home.
Best of luck!
@Valerie... I should be asking my lender this but i feel more comfortable here hmm. e u can refer me to ur lender afterall. Thanks