With the housing market seeing signs of a double dip in prices,
homeowners who got in over their heads
have looked to save money by any means necessary. Now, thanks to
extremely low interest rates,
are luring borrowers away from locking in rates with longer-term
fixed mortgages. Although you can score from savings in the short
run, choosing an ARM over a fixed-rate mortgage could prove to be a
big mistake in the long run.
Low and lower
When it comes to mortgages, homebuyers have never had it so good.
After a brief spike earlier this year, rates on 30-year fixed
mortgages have headed down again, falling below the 4.5% level.
That's not quite as low as we saw in
, but it's still historically quite attractive.
But for those willing to take on interest rate risk,
adjustable-rate mortgages have rates that are even lower. With
one-year ARM rates approaching 3%, the difference of 1.5 percentage
points represents $250 a month in lower interest on a $200,000
mortgage. HSH Associates reports that the rate difference between
ARMs that reset after five years and fixed mortgages is as wide as
it's been since the heart of the housing boom in 2003.
Should you follow the REITs?
In many ways, choosing an ARM over a fixed-rate mortgage is similar
) , and
American Capital Agency
(Nasdaq: AGNC) have done to generate such huge profits in recent
years. Essentially, taking out an ARM gives you the benefit of
borrowing at lower short-term rates, in exchange for a long-term
obligation -- in this case, owning your home. That has worked well
in this rate environment, because short-term rates have stayed at
rock-bottom levels for so long.
Similarly, ARM borrowers will enjoy cheap interest payments as
long as rates remain low. The risk that they share with mortgage
REITs, though, is that if short-term rates spike upward, your
borrowing costs will skyrocket. That got many borrowers in trouble
during the housing boom, as homeowners discovered that they really
couldn't afford to make mortgage payments once rates returned to
A bad reputation
The fact that borrowers used ARMs as the only possible way to
afford buying homes gave these loans their bad reputation during
the initial part of the housing bust. Option ARMs with negative
amortization offered homeowners deceptively cheap payments that
were set to balloon upward a few years later. And while some banks,
) , didn't originate option ARMs themselves, plenty of now-vanished
lenders, including Countrywide, Wachovia, and Washington Mutual,
did. So now, Countrywide-acquirer
Bank of America
) , Wachovia-buyer Wells Fargo, and WaMu asset purchaser
(JPM) have ended up with plenty of option ARMs.
As it turned out, interest rates have stayed low throughout the
initial period of option-ARM resets, saving many borrowers from the
possibility of much higher payments. But eventually, interest rates
will go up. And while fixed-rate mortgage borrowers will enjoy
their current low-ish rate as long as they own their homes, ARM
borrowers may well find themselves in the uncomfortable position of
trying to figure out whether to eat much higher interest charges,
or refinance into a fixed-rate mortgage at a higher rate than the
ones now available.
Middle of the road?
One middle-ground solution between a pure ARM and a fixed mortgage
is to consider ARMs that let you lock in your rate for longer
periods of time. ARMs with five- or even seven-year fixed periods
can give you a discount to fixed mortgage rates, and if you end up
moving or refinancing before then -- or if you're able to pay off a
significant part of your debt -- then the savings is yours to
Saving money on interest charges is always an attractive way to
cut costs. But with ARMs, what you get now could cost you later.
Whether you can save using an ARM over a fixed mortgage depends on
your own personal situation, but one thing is certain: ARMs aren't
a no-brainer smart move for everyone, and they could end up being a
replaced his mortgage with a low-rate home equity line of
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