Home > Mortgages > Adjustable-Rate Mortgages Look Good: Should You Bite?

Comments 0 Comments
Advertiser Disclosure


You can get a 30-year fixed-rate mortgage at about 4% today. That’s a great deal.

But maybe you’ve noticed that adjustable-rate mortgages are even cheaper. You’ll find ARMs with rates as low as 2.64% to 2.96%, depending on the loan term.

The Potential Savings

Wow. That’s pretty tempting. Your savings could be big. Suppose you borrow $100,000. Here’s the comparison with a fixed-rate mortgage:

  • 30-year fixed-rate mortgage. At 4.1% your monthly payment (not including taxes, fees, points, home insurance or mortgage insurance) would be about $483 a month.
  • 5/1 hybrid adjustable-rate mortgage. At 2.96%, your payments (without taxes, fees and all the rest) would be about $419 a month for the first five years — saving $64 a month.

I used Zillow.com’s mortgage calculator for this estimate. Use your own numbers to estimate your own scenario.

Big Risk

There’s a catch, of course. After those first five years, things change. ARMs are called adjustable for a reason: The size of your monthly payment can swell or shrink as interest rates rise and fall.

“Hybrid” ARMs, like this one, are like hybrid cars: You’ve got two systems in one vehicle. The ARM starts with a low fixed rate for a set period — five years in this case. When that ends, your cheap, dependable monthly payments are over. Now your payments can rise, fall or stay the same, depending on current mortgage rates.

A 5/1 hybrid ARM like the one in our example has a five-year fixed-rate period followed by an adjustable period in which the interest rate is recalculated, or “reset,” every year.

Here’s what AARP says about the risk:

Caps limit how much the rate can increase at each adjustment. But over time, the rate can climb significantly, making your payments much harder to afford. Some ARMs can rise as much as 6 percentage points during a 30-year term.

You can easily get into hot water. As The Wall Street Journal writes, about the current popularity of 1/1 ARMs among wealthy consumers:

Rates on a 1/1 ARM can rise by as much as six percentage points, based on most loan terms. A borrower who signs up for a 1/1 ARM at a 3.05 percent rate, which mortgage information website HSH.com cites as the average rate, could see the rate rise to a maximum of 9.05 percent during the life of the loan. With ARMs that have a one-month fixed-rate period, rates can jump by 10 or more percentage points over the life of the loan.

Today’s interest rates are low and may start rising soon. So it would be a mistake to get an ARM, betting you won’t have rate increases. The increases could wipe out any savings from your cheap, fixed-rate period.

So who’s the right customer for an ARM? It might be right for you if:

You’re Not Sticking Around

If you plan to move before your fixed-rate period expires, you could buy a home at a very cheap price. Says Realtor.com, “Someone who has a payment that’s $100 less with an ARM can save that money and earn more off it in a higher-yielding investment.”

You can’t count on being able to sell your home to get out of an ARM, however. AARP’s primer on adjustable-rate mortgages, published in 2011, says:

But if the housing market in five years is anything like today’s market, you could have a very difficult time selling. And that means you’d be stuck with an ARM that resets to a higher rate and a higher monthly payment.

It’s also risky to assume you’ll be able to refinance out of your ARM when the payments reset. What if you can’t get a mortgage?

You’re Rich

If you have the cash to easily pay off your mortgage when the rate starts climbing, you’re in good shape. But few of us can do that.

Wealthy borrowers are using 1/1 ARMs as part of a sophisticated strategy described by the Journal:

High-net-worth borrowers also are using these mortgages as leverage against their investments, says Frank Destra, managing director and head of UBS Mortgage. Because of their low rates, 1/1 ARMs could allow them to maintain a comfortable spread between the interest rate they’re paying out on their mortgage debt and the returns they are earning from their investment portfolio even when rates start to rise.

Not for Amateurs

ARM contracts are complex beasts. Mind-numbing provisions lay out the rules on how much your payments can rise or fall, how often and whether there’s a limit or cap on the increases.

Don’t make this decision without help. While ARMs no longer have the kind of sketchy features that made them infamous in the housing boom — negative-amortization ARMs that could grow your debt larger, for example, or exploding-rate ARMs with superhigh rate increases — they’re still risky investments for all but the most experienced consumers.

Find a trustworthy adviser. That’s not a mortgage lender or broker who’s trying to sell you a mortgage, or an adviser charging big fees, or any fees before delivering a service.

You’ll find free or cheap advice from these nonprofit agencies:

Learn more about ARMs from the Federal Reserve’s Consumer Handbook on Adjustable-Rate Mortgages. This MyFICO mortgage calculator lets you compare adjustable and fixed-rate mortgages.

This post originally appeared on Money Talks News.

More from Money Talks News:

Image: iStock

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Credit.com receives compensation for the financial products and services advertised on this site if our users apply for and sign up for any of them.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team