I'm about to buy a house and can really lower my monthly payment by taking an adjustable-rate mortgage rather than a fixed-rate one. But I'm worried that this might be a bad idea since interest rates are starting to rise. What do you think?
It all depends on how long you expect to live in the house. You can save a significant amount of money in monthly payments if you go with an ARM, and you won't have to worry about rising interest rates as long as you move or refinance before the rate adjusts.
With a hybrid 5/1 ARM, for example, your rate is fixed for the first five years then adjusts annually. If you move before five years, you never need to worry about what happens to rates. Interest rates on 5/1 ARMs are running about 1 percentage point below those for a 30-year fixed mortgage. That percentage point results in a smaller monthly payment -- $1,289 for a 5/1 ARM at 4.65% on a $250,000 loan, for example, versus $1,439 for a 30-year fixed mortgage at 5.63%. The difference in payments totals $9,000 over five years, and you'd pay off more than $3,100 in principal with the lower cost ARM over that time period, too.
Even if you choose to stay in the home for years after the fixed portion of the loan expires, you could come out ahead, depending on the how much your loan can adjust and how often.
Be sure to read the fine print. Find out how the rates are calculated, including what index it's tied to, how quickly the rate can adjust after the fixed period is over -- some inch up annually, but others move every six months or even monthly -- and the maximum increase over the life of the loan. Figure out how high it can jump at the end of the fixed term, as well as the worst-case scenario. Once you've gathered the details, run your numbers through our Fixed or Adjustable Rate calculator to determine which loan is a better deal for you.
Check out our mortgage page to compare the latest rates and ARM options in your area.
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