Why an ARM may be a better than a fixed-rate mortgage

I read this article today and I agree with it wholeheartedly. Sometimes an ARM is the best choice for your mortgage and financial plans. For instance if your plans to live in a home are just for another five, seven or ten years than many times an ARM can save you tens of thousands of dollars in interest payments over the years. Here are some quick quote from the article:

Assuming a $300,000 loan amount, a 30-year fixed-rate mortgage at 5.13% means a monthly payment of $1,634, said Keith Gumbinger, vice president of HSH Associates, a publisher of consumer loan information. Interest paid after five years: $74,053.

Compare that to a 5/1 hybrid adjustable-rate mortgage at 3.83%. For the first five years, the monthly payment would be $1,403, and you’d pay $54,771 in interest over those five years, Gumbinger said.

So, for a borrower who plans on moving within five years anyway, they’d save as much as $19,283 by financing with an ARM. For the examples, Gumbinger used HSH’s four-day cumulative rate averages from Feb. 7 through 10.

In the above example the borrower would save $10,954 a year in mortgage payments, money that could be used to pay-down other debt, added to the monthly mortgage payment to pay down the balance quicker or add to a retirement fund.

And this about the end of the fixed period of an ARM:

“It’s certainly worth saying that many borrowers overpay or overbuy the security that they need,” Gumbinger said. But “unless you can say with certainty where you will be in five years, you will have a little level of discomfort about what could occur” if you accept an ARM, he said.

That’s because — in the case of the 5-year ARM — the rate will reset at month 61, adjusting to market conditions. If, say, that ARM reset three percentage points higher (a hypothetical, since it’s unknown by how much it would reset) that would could mean a new monthly payment about $480 higher, Gumbinger said.

But if the savings from taking the 5-year ARM over the 30-year fixed-rate mortgage is banked and used for when the rate resets (again assuming that three percentage point hypothetical increase) you’d feel no budgetary stress from the payment increase for about 40 months, he said.

And if you do choose an adjustable mortgage, prepare in advance for the end of the fixed-rate period by socking money away in order to comfortably handle a possible increase in monthly payment when it hits. That, or use the savings toward paying down the principal so when the mortgage resets you have a smaller amount to pay interest on.

You can read the whole article here.

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