Beware This Mercurial Mortgage

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Mortgage borrowers have received a call to arms lately -- or rather, a call to ARMs, or adjustable-rate mortgages. Unfortunately, for many people, this increasingly popular variety of loan just isn't the best choice.

Nuts and bolts
Mortgages come in two main flavors, bearing either fixed or adjustable rates. The interest you pay on a fixed-rate mortgage stays the same for the life of the loan. If you lock in a low rate, you're set for decades, and you'll always know how much to pay each month.

ARMs fix their rates for an initial period, but then begin to adjust the interest they charge according to prevailing rates. A cap usually limits how much rates can rise with each increase, but over time, interest can grow substantially, leaving borrowers on the hook for ever-steeper payments.


To see why people will gravitate toward ARMs, check out recent mortgage rates from US Bancorp , below. (All feature no points paid.)

Type of Mortgage

Interest Rate

30-year fixed-rate mortgage 4.875%
15-year fixed-rate mortgage 4.25%
3/1 ARM (fixed for three years, then adjusting) 3.125%
5/1 ARM (fixed for five years, then adjusting) 3.5%

Source: US Bancorp, as of March 25.

The lower rates for the ARMs mean lower initial monthly mortgage payments, which can make a big difference for borrowers trying to afford a certain home .

Adjustable-rate mortgages have been cited as a contributor to the recent housing crisis; many troublesome subprime loans were ARMs, sold to unsavvy borrowers. Indeed, some lenders are still digging out from that mess. In October, Wells Fargo ( WFC ) struck a deal with many states, agreeing to forfeit hundreds of millions of dollars to settle claims that the company's mortgage subsidiaries may have deceptively marketed extra-risky ARMs.

ARMs up
In recent years, ARMs had fallen out of favor. But now the mortgage scene is changing , and ARMs are back. At Bank of America ( BAC ) , sales of ARMs recently doubled year over year; overall, ARMs now make up 10% of home loans. For context, in 1994, when fixed-rate 30-year loans had average interest rates between 7% and 9%, ARMs accounted for 70% of all mortgages nationwide.

If you're in the market for a mortgage, deliberate carefully between fixed-rate and adjustable-rate loans. The ARM can bite you if rates rise -- and after lingering near historic lows for years, rates most certainly will increase. Still, low rates may persist for several more years, and if you don't plan to stay in your home much longer than that, an ARM can make good sense.

Keep your eye on major mortgage lenders by adding them to your watchlist:

  • Add Bank of America to My Watchlist.
  • Add Wells Fargo to My Watchlist.
  • Add US Bancorp to My Watchlist.

Don't have a watchlist? Sign up now and you'll get immediate access to a new special report, "6 Stocks to Watch from David and Tom Gardner." Click here to get started -- it's all free.

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Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. The Fool owns shares of Bank of America and Wells Fargo. Through a separate account in its Rising Star Portfolios, the Fool also has a short position on Bank of America. Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Personal Finance , Banking and Loans

Referenced Stocks: BAC , WFC

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