Why You Might Consider an ARM


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You don't hear much about adjustable-rate mortgages (ARMs) these days. With interest-rates on fixed-rate home loans as low as they are, and a somewhat tainted reputation from the days of the housing boom, ARMs aren't as popular as they once were. But for the right kind of borrower, they're still an attractive option.

Presently, an ARM can make sense if you're in any of the following situations:

  • You don't plan to stay in the home a long time
  • You want to build home equity quickly
  • You're thinking about a 15-year loan but want to stay flexible with your payments
  • You plan to pay off your home on an accelerated schedule

Here's why:

For short-term homeowners

First, it doesn't make sense to lock in a mortgage rate for 30 years if you're sure you're not going to own the home for that long. It's very common for people to only stay in a home for five to seven years before moving on, particularly if they're in a profession that involves occasional relocation.

If you're confident that you're not going to stay in a home beyond a certain length of time, you can get an ARM to match and save some money compared to a 30-year fixed-rate loan. ARMs are available with initial terms ranging from one to 10 years, so you can find one to match the length of time you'll be in the home.

Build home equity quickly

Second, an ARM can also make sense if your goal is to build up equity as quickly as possible. Currently, you can get a 7/1 ARM with an initial rate that's about three-quarters of a percentage point lower than on a comparable 30-year fixed-rate mortgage, perhaps more. That means a savings of about $125 a month on a $300,000 mortgage, or more than $10,000 over those seven years.

If you put that extra $125 toward your mortgage payment, you'll have that much additional home equity at the end of those seven years. You can then use that equity toward the purchase of your next home, if that's your intention.

If you originally put down less than a 20 percent down payment on your home, building up equity more quickly can advance the date when you can cancel private mortgage insurance (PMI). Since the annual cost of private mortgage insurance is typically about one-half to 1 percent of your loan amount, getting rid of it is like reducing your mortgage rate by that same amount.

As an alternative to 15-year fixed-rate loans

Third, ARMs can be a useful option for those who are thinking of refinancing to a 15-year mortgage but are concerned about committing to the higher monthly payments. Since ARMs are designed to amortize over 30 years, you can get a loan with an interest rate comparable to a 15-year fixed-rate loan but with a much lower minimum monthly payment.

If you then make the same payments as you would have with the 15-year loan, you can enjoy the financial advantages of a 15-year mortgage while maintaining the flexibility to make lower monthly payments should the need arise.

Of course, if you go this route you may want to refinance again after seven years or whatever the initial period of your ARM was. But if you've kept up with your 15-year payment schedule, you'll have significantly reduced your mortgage balance and have less principle to pay interest on with the new loan.

On a similar note, some people use ARMs for purchases because they plan to pay their home off quickly and are looking for the lowest rate possible. This is often the case with well-to-do borrowers who are taking out jumbo mortgages with high interest rates. They may make a down payment of 30 percent or more and intend to pay off the entire loan within seven to 10 years, so an ARM makes sense for them.

Are ARMs trustworthy?

Adjustable-rate mortgages got a bad reputation because they were used in a lot of the high-risk loans that led to the crash of the housing market. But that had more to do with how those loans were structured, rather than the simple fact they were ARMs. When features such as negative amortization were combined with loans sold to borrowers who could barely afford them in the first place, it's no surprise that so many of them imploded.

In reality, ARMs are a very traditional type of mortgage. In fact, in many countries they're the main type of home loan. As long as you understand how they work, they can be a very solid and responsible way to finance a home purchase.

With fixed-rate mortgages such a bargain right now, most borrowers don't bother trying to shave their rates even more by taking out an ARM. They figure, probably correctly, that mortgage rates aren't likely to stay this low and their best bet is to lock in today's rates for as long as they can. However, there's still a market for them and if any of the above situations apply to you, an ARM is something worth investigating.

This article was originally published on MorgageLoan.com at: http://www.mortgageloan.com/why-you-might-consider-arm-9346

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

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