Adjustable rate mortgage or a fixed rate?
December 22, 2006 | Mortgage | 
2 comments
Both have their proper use. Many borrowers are under the impression that an adjustable rate mortgage (ARM) is very risky and can leave you with higher payments that you can’t afford. This is true but only if you do not know what they are, and how they work. Both have a definite value if used properly. Lets look at when each should be used.
As I discuss in many articles, selecting a mortgage should be based on your intended holding period, expected needs for future cash or consolidation etc. How long do you intend to keep the loan? If you are in a home that you intend to keep and this is a long term goal you should not be considering an ARM at this time unless you see a need for cash or consolidation of debt within the next 5 years. Fixed rates are within 1.5% of the lowest they have ever been and very much under the historical averages so if plans are 5 years+ I highly recommend a 30 year fixed rate loan.
However, if you are planning on moving within 5 years, or may need cash in the foreseeable future (kid going to college, payoff 2nd mortgage when values come back etc.) then an adjustable with a shorter term fixed rate period is an excellent choice.
The interest rate you get is directly related to how long the lender guarantees a fixed rate for. A 30 year fixed rate will be higher than a 2 year fixed rate. With this said, it makes no sense to pay a higher rate for a 30 year fixed period if you intend to keep the loan for 5 years or less. ARM’s are available with anywhere from a 10 year fixed rate period down to an ARM that will adjust every month. By selecting an ARM that meets your requirements you will save significantly. At this time the 5 year fixed rate loans are about .375% - .50% lower in interest rate than a 30 year fixed.
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[...] The main culprit is the subprime adjustable rate mortgages which have made borrowing easy for many Americans. The low monthly payment seems very attractive and will get many of these borrowers into the home but as the loan converts to an adjustable the payment shock hits and the decline begins. [...]