ARMs Are Getting a Bad Rap

Don't let bad press drive you away from a pretty good mortgage deal.

Selena Maranjian
Selena Maranjian
Apr 4, 2007 at 12:00AM
Other

I wouldn't want to be an adjustable-rate mortgage these days. ARMs are getting a lot of flak in the press. Just look at this snippet from an article by Phil Rooney in the Council Bluffs, Iowa, Daily Nonpareil:

"Now the concerns are growing, as some stock market dips around the world have been blamed, at least in part, on mortgage foreclosures. ... Rising interest rates and weak home prices have made it increasingly difficult for those borrowers -- especially those with adjustable-rate mortgages -- to keep up with their mortgage payments. Delinquencies and foreclosures in the subprime mortgage market are spiking."

See? ARMs are often being singled out and blamed -- but they're not necessarily so bad.

In a nutshell
While a fixed-rate mortgage carries the same interest rate throughout its life, adjustable-rate mortgages offer fluctuating rates. You can expect an ARM to offer you a teaser rate for the first year, which is typically considerably lower than prevailing market rates. Then the adjustments start, and the loan's rate ratchets up or down according to how interest rates in general are moving.

The rates typically can't spike too much, too quickly, because there are caps restricting the range. If you have a 5% teaser rate, for example, and a five-point cap, your rate will never exceed 10%. The amount by which your interest rate can rise each year is also limited, usually to one or two percentage points per year.

That might sound scary, but it doesn't have to be. For some people in certain circumstances, ARMs are the best bet. Since ARMs come in many varieties, if you're pretty sure you'll be staying in your home for only a few years, you can get something like a "5-1" ARM, where the rate is fixed for the first five years and then resets each year after that. While 30-year fixed-mortgage rates recently averaged 5.68%, according to Bankrate.com, 5-1 ARMs were in the 5.45% range. Depending on how much you're borrowing, that lower rate can save you quite a bit over a fixed mortgage. There are 7-1 ARMs and 10-1 ARMs and many other related loans, too, to suit different needs.

Learn more
You can learn a lot more about ARMs in other Fool articles. In "Shedding Some Light on Subprime Lenders," for example, Emil Lee interviewed a mortgage specialist who had good things to say about several mortgage-lending companies. Meanwhile, in "Relax, We're Not Subprime!," Seth Jayson questioned the sturdiness of one particular lender's underwriting standards. And in "No Bailouts for Anyone," Nathan Parmelee offered some thoughts on various shaky lenders.

In the meantime, if you're in the market for a mortgage, do consider ARMs -- just avoid the extra-risky ones, such as "option adjustable" ARMs and "interest-only" mortgages. Learn to be a smart buyer in our Home Center, which features lots of money-saving tips. You might also want to check out these articles, especially if you'll soon be buying a new home:

Longtime Fool contributor Selena Maranjian appreciates your comments. The Motley Fool isFools writing for Fools .


Related Articles