The Benefits of an ARM

Most people find it surprising that a home buyer with an ARM usually pays less for their home than one with a fixed loan. There are a couple of reasons why.

This section:

  • Explains when an ARM is a wise investment

  • Explains the vital difference between rate and payment caps

  • Helps you decide if an ARM is the right loan for your plans

If you missed it we already looked at 30 year and 15 year fixed rate mortgages. Next we look at special mortgages for those with particular financial needs.

The second part of this guide examines the rest of the decisions you'll have to make when choosing your mortgage. Refer to the table of contents if you're looking for specific information.

What are the benefits of an ARM?

There is one major reason an ARM saves home buyers money A typical American family stays in any one house for an average of only eight years. They don't ever "use" the stability of the long-term fixed rate. So quite often, an ARM, with its initial low rate, is actually the cheapest mortgage choice.

An ARM is ideal for those who don't plan on staying in one place for very much time, but who would like to build home equity rather than pay rent. In general, the shorter the time you think it's likely you'll stay in your new home, the more seriously you should consider an ARM.

During an ARM's initial fixed rate period, the loan's interest rate is usually set quite a bit lower than you would be able to find on a FRM with the same term.

(Unlike FRMs, ARMs are almost always amortized over 30-years, no matter what the length of the initial fixed-rate period.)

By choosing an ARM with an initial fixed rate period of roughly the same length as your expected stay in your new home, you can build home equity while paying the least possible in interest.

Overall, an ARM is almost certainly the best deal for you if you plan on staying in your new home for five years or less.

Of course, an adjustable rate is always something of a gamble, because plans change and you may end up staying longer than you anticipated. That's why lenders offer the best deal on a 1-year fixed ARM and the rate gets higher as the fixed period gets longer.

But that's not to say you'll be "taken for a ride" if you end up staying longer than anticipated. You can always refinance if you need to and, while that's not cheap, the savings at the start of an ARM can be substantial.

But there's another time an ARM is the way to go . . .

When interest rates are high, an adjustable rate mortgage can help save you thousands in interest.

Interest rates tend to move in long cycles, with a gradual rise followed by a similar slow drop. Ideally, a prospective home buyer has the luxury of waiting for rates to fall and then quickly locking into the lowest possible rate.

However, not everyone is so fortunate. If you want or need to buy a new home now but interest rates are high, an ARM can allow you to begin building home equity without having to commit to a high interest rate.

A regular, prime ARM always has a low initial fixed interest rate, which converts to an adjustable rate mortgage after some specified time period. The adjustable rate will be tied to some index rate (like one-year Treasury bills) plus a margin of a few points added by the lender.

If you're following interest rates and you think they're too high to commit to a fixed rate mortgage, an ARM can give you a cheaper initial period of anywhere from one to ten years, after which your loan converts to an adjustable one following the specified index rate.

If rates do fall, you've saved yourself a lot of money while building home equity. If, however, they go even higher, you can be in for an unpleasant surprise when the adjustments start. Because of this, it's always a good idea to stash away some of your monthly savings in case you have to refinance when the fixed rate period expires.

Sidebar
When interest rates are low, ARMs are less attractive. However, if you do not plan on living in your home for long, you will save cash by applying for an ARM. Try Eloan if your credit score is higher than 620, or FullSpectrum Lending if you know that you've had credit problems in the past.

ARMs can be a great option for the savvy home buyer when interest rates are high. If you don't mind (and can afford!) the possibility that you may need to refinance later on, an adjustable rate mortgage can allow you to build home equity fairly cheaply even in a high-rate environment.

And, they're fairly easy to tailor to your specific needs and expectations:

If you think you know that a downturn in interest rates is likely to occur, you can design your mortgage accordingly.

Let's say interest rates are fair, but you expect them go even higher for about the next two years and then start falling. A 3-year fixed ARM (or "hybrid mortgage") could be ideal for you. You're able to take advantage of the artificially low fixed rate for the next three years, and then, when the adjustments kick in, you reap the advantage of the now-falling interest rates.

Of course, no one can be sure what the interest rate market will do, which can make your guessing game quite a gamble. That is, unless you think there's a good chance you're moving again sometime in the near future. If this is the case you'll be able to act on your hunches with a lot less risk and allow yourself some flexibility as well.

cash saving mortgages.



Next: Special mortgages

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