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Interest rates are hovering near historic lows. So if you're buying a home, you should lock in a good deal with a 30-year, fixed-rate mortgage, right? Advocates of adjustable-rate mortgages would argue otherwise. Depending on your circumstances, their arguments could be worth considering - although adjustable mortgages can involve serious risks, primarily because their rates are guaranteed to rise in the years to come.
1. You can save in the near term. At the outset, an ARM can shave several hundred dollars off your monthly mortgage payment - savings that could make it possible for you to afford to buy a home.
2. But there's a need for caution. When the adjustable period of your mortgage kicks in, your monthly payments could skyrocket to levels you won't be able to afford, especially if your income hasn't increased significantly by then.
3. New rules could hurt you. Thanks to a recent change pushed by lenders, your mortgage rate can jump as much as 5 percentage points as soon as the fixed-rate segment of your ARM expires. In the past, 2-point annual rate caps helped protect consumers from such potential shock.
4. Count the costs. Ask your mortgage lender to calculate the savings you could initially experience with a hybrid ARM, as well as the expenses you could incur over time with a rate increase of 2 to 5 percent. Do similar calculations involving a fixed-rate mortgage and compare the costs over time.
5. How long will you stay in your house? If you're positive you'll be there only a few years, opt for an ARM. If you're not sure, select a fixed-rate mortgage.
6. Some stability could meet your needs. Popular hybrid ARMs have a fixed rate for their first one, three, five, seven or 10 years, then adjust annually. If you know your job will transfer you to a new location within three years, consider an ARM that offers the stability of a fixed rate for three years.
7. Beware of overextending yourself. With any mortgage, monthly payments for principal, interest, taxes and insurance should not exceed 31 percent of your gross income.
8. Don't confuse an ARM with a balloon mortgage. With a true ARM, the borrower pays back a portion of the principal with each loan payment. With other loans, such as interest-only loans or balloon mortgages, you can make payments for a period of years without repaying any of the original principal. This can lead to nasty surprises down the road.
9. Seek flexibility. Some lenders offer ARMs that let you make payments in a variety of ways. At one point you temporarily could make interest-only payments to free up some cash, and at another point you could follow an accelerated payment schedule and retire the 30-year mortgage early.
10. Like the seasons, markets change. If interest rates are high when the initial fixed period of your mortgage ends, be aware that it could take longer than anticipated to sell your house. In a worst-case scenario, you could face foreclosure.
- Sources: Consumer Reports (www.consumerreports.org) Bankrate.com (www.bankrate.com)