Should You Get An ARM?
One of the most popular ways to finance a home these days is the Adjustable Rate Mortgage (ARM) because the initial interest rates and closing costs are typically lower than fixed-rate loans. The lender assumes the greater risk with a fixed rate mortgage because no matter how high interest rates go, the borrower’s interest is locked in for 30 years. That’s why fixed interest rate loans have higher interest rates.
ARM qualifying rates are less than fixed-rate loans, so lenders also offer ARM borrowers more liberal qualification ratios. The ARM interest rate is determined by an "index" that fluctuates with economic conditions and a "margin." A typical rate cap on an annual basis is 2 percent, or 2 percent above or below the previous year's rate.
An ARM is a good idea if:
ARM interest levels are significantly below fixed-rate interest charges.
You won’t be staying in the house for more than five years (especially if you have a locked-in rate for the first three, five or seven years).
You anticipate a higher income in the future (such as a young professional just starting out).
You anticipate that rates are going to drop and you plan to refinance when they bottom out.
ARMs are not a good idea if:
Initial rates are comparable to fixed-rate loan rates.
High closing costs offset the low interest rate.