And the interest rate on a 5/1 ARM is fixed for the first five years before becoming annually adjustable, so there’s relative safety there if you don’t plan on sticking around for long. For instance, if you sell or refinance before those five years are up, you could save a ton of money over those 60 months.
Let’s look at a quick example to illustrate:
30-year fixed @ 4%: $1432.25
5/1 ARM @ 2.75%: $1224.72
On a $300,000 loan amount, the difference in monthly mortgage payment is roughly $200 a month. Over five years, that’s $12,000. Not an incidental amount by any stretch, but there has to be a catch, right?
Well, we’re in a unique spot at the moment. Mortgage rates are pretty much in unprecedented territory.
They’re not absolutely rock-bottom, as they’ve risen in the past few weeks, but they’re still at lows not seen pretty much ever in our lifetimes.
So looking a gift horse in the mouth might not be the smartest move.
Mortgage Rates Have Nowhere To Go But Up
Unfortunately, the general consensus is that mortgage rates have nowhere to go but up. That’s pretty much not debatable, given they can’t go much lower, but the big question is when?
They could rise quite quickly if the economy gets back on track in a hurry, which is a must eventually, right?
So if you reside in a home that you plan on living in for the foreseeable future, gambling on an ARM right now may burn you in the near future.
Sure, you may save money over the next 5+ years, but after that, you may find that mortgage rates have surged.
At that point, when your ARM is set for its first adjustment, it will most likely adjust higher. And potentially a lot higher.
And let’s face it, five years can go by in the blink of an eye.
Don’t Choose an ARM If You Can’t Handle the Higher Payment
If you can’t handle that interest rate uncertainty, and don’t know if you’ll be selling before the adjustable period ends, an ARM probably isn’t a good choice right now.
Once interest rates rise, you’ll be stuck with a larger monthly payment, or forced to refinance to stop the bleeding.
Think of it this way. At the moment, affordability is a lot higher because interest rates are really low and home prices have fallen from their highs.
In the future, assuming both home prices and interest rates rise, you may not qualify for a new mortgage, even if you loan amount goes down. So you could be stuck with what you’ve got.
Would you rather be stuck in an ARM that’s constantly rising, or a fixed-rate mortgage in the low 4% range?
If you’re super confident you’ll move, or be able to refinance no matter what transpires, you can take a chance, but there are probably better times to do so.
Read more: 30-year fixed vs. ARM
(photo: Travis Hornung)