Is an adjustable-rate mortgage good for you?
Mar 2011 20

There have been extraordinary changes in the ways that Americans finance their home purchases.

Back in the mid-1990′s, adjustable rate mortgages (ARMs) were used for around 70 percent of all home purchases, according to a study by the Federal Reserve Bank of New York and reported by the New York Times, this week.

Things took a 180-degree turn, however, during the past couple of years as borrowers feared the risk of taking out loans that, in an uncertain economy, could have skyrocketed in loan repayment amounts at any time.

Now, however, as we return to the “new normalcy”, homebuyers are considering ARMs, once again. A thaw in the frozen credit markets is helping, too.

Mortgage brokers and lenders say the loans most in demand are the “5/1” and “7/1,” in which the initial interest rate is fixed for the first five or seven years — after which many homeowners typically think about selling or refinancing anyway — then adjusted annually at a capped rate toward a maximum level.

In contrast to fixed-rate loans, whose interest rates never change, ARMs start out at one rate and then adjust typically once a year at a capped rate, often two percentage points, based on changes in the interest-rate indexes to which they are tied. The adjusted rates can go up or down, and the total increase over the life of the loan is capped.

Current rates on ARMs are lower although not as good a deal as before. While a fixed-rate mortgage loan might run you 4.76% in today’s market, an ARM might come with a loan rate of 4.04%. The monthly savings on a $400,000 loan is ~$171 per month. More importantly, you’d be saving thousands of dollars in interest over the term of the loan.

There are mighty risks to taking out an ARM. Most people, at least today, are not willing to carry that risk. The fear of future interest rate jumps means they can’t budget their monthly expenses going forward. For those with short-term owning plans, who might be moving out before their rates adjust, it might be worth checking out.

More: More Borrowers Are Opting for Adjustable-Rate Mortgages – Lynnley Browning, The New York Times

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