Is an Adjustable Rate Mortgage Right for You?

home sold

Cape or Colonial? Three bedrooms or four? Hardwood floors or wall-to-wall carpet? Use a realtor or handle the negotiations yourself? Make a 20 percent down payment or not?

To say that there a ton of decisions to make when buying a house is certainly an understatement.

The most important decision to make, however, is choosing which type of mortgage to get: Fixed-rate or adjustable-rate?

As a result of the housing crisis, it was virtually impossible to get an adjustable-rate mortgage (ARM) in recent years. And with interest rates on fixed-rate mortgages at historic lows, borrowers weren’t really looking to sign up for them either. But with interest rates slowly on the rise, an ARM is looking more attractive now. (Case in point: The Mortgage Bankers Association reports that 8 percent of all mortgage applications are for ARMs.) Should you seriously think about getting one?

Since many people ultimately decide between the two types of loans based upon their bottom dollar, one of the main things to consider is how their interest rates differ. Currently, Wells Fargo offers a five-year ARM for 3.375 percent in contrast to 4.5 percent for a 30-year fixed loan. Chase’s loan options include an ARM carrying an interest rate of 3.25 percent and a 30-year fixed mortgage with an interest rate of 4.375 percent.

The adjustable-rate seems to be the winner over the fixed-rate. Well, not so fast.

With a fixed-rate mortgage, you can calculate how much interest you’re going to pay over the life the loan—making your total mortgage costs completely transparent. That’s not the case with an adjustable rate mortgage because it has an interest rate that is usually fixed for specific amount of time, after which it can vary based upon the specific index it follows. (For example, a 5/1 ARM has a fixed interest rate for the first five years and then it adjusts each year after that.) And while an ARM does have a cap on how much its interest rate can rise, you can’t predict what interest rates will be, say, 12 years from now—so it’s impossible to get a complete picture of your financial responsibilities with this type of loan. And if the variable interest rate rises significantly, you could end up with a monthly mortgage payment that’s much costlier.

If you’re planning on staying in your home for just a few years, for around the same amount of time as the introductory period of your adjustable-rate loan, or if you plan to pay off the loan early, then getting an ARM could be the smarter financial decision. But if you’re unsure how long you’re remain in the residence, you plan to live there indefinitely, or you know you use the entire length of the loan to pay off the balance, signing up for a fixed-rate loan is the safer option.

So while the adjustable-rate mortgage looks to be back on the market, keep in mind that gambling on it may not be right for you.

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Published January 22, 2014 Updated: January 20, 2014
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