Donnerstag, 9. Juni 2011

When An Adjustable Rate Mortgage Isn’t Financial Suicide

The credit crunch has made borrowing unfashionable and I’m sure I will be viciously attacked for this, but yes, the much-maligned adjustable rate mortgage does have a place in post-crash society!  That’s not to say you should run out and take out an adjustable rate mortgage, however.  Like anything, there are pros and cons to consider before making a final decision.
These mortgages were severely abused throughout most of the decade, but that’s no reason to throw the baby out with the bathwater.  The average adjustable rate mortgage carries a lower initial interest rate than the average fixed-rate mortgage, at least before the first adjustment, potentially saving you thousands.  And if interest rates happen to fall, your payment could actually end up decreasing rather than increasing.  Of course, the opposite is true if rates go up.
Here are some situations where taking out an adjustable rate mortgage is okay and unlikely to cause you permanent financial harm.

When An Adjustable Rate Mortgage Could Make Sense

  • You Can Afford The Worst-Case Scenario – This is rule #1, and by far the most important.  If you aren’t absolutely certain you can afford the worst-case scenario should things not work out as planned, you can’t afford an adjustable rate mortgage.  Period.  Fudging the numbers here could lead to disaster.
  • You Have Excellent Credit And Ample Cash Reserves – If you have mediocre credit, you might be unable to refinance into a fixed-rate loan if events turn against you.  Ditto if you don’t have ample cash reserves to put up a sizable down-payment.  If your financial position is borderline, stick with the safety of a fixed-rate mortgage.  It’s simply not worth the risk.
  • You Plan To Sell Before The Loan Readjusts – If your ARM is set to reset in 5 years and you plan to sell (or refinance) within 4 and are confident of your ability to do so, it probably makes sense to go with an adjustable rate mortgage assuming you can get enough of a rate discount to justify the trouble and refinancing costs.
  • Interest Rates Are High And You Expect Them To Decline – This probably doesn’t apply right now, but in general, refinancing a fixed-rate mortgage is expensive (beware co-called “no cost refinance ” loans).  If you think rates are heading south (not easy to predict), you can save yourself some refinancing costs by riding an adjustable rate mortgage down rather than having to refinance.  This is an admittedly risky endeavor, but if you have the ability to take on a bit of risk for a sizable return, why not give it a go?

When An Adjustable Rate Mortgage Is A Bad Idea

  • It’s The Only Way You Can Afford To Buy – If you can’t afford a fixed-rate mortgage, you can’t afford to buy a home.  Period.  Stretching yourself so thin is a recipe for disaster.
  • You Can’t Afford The Worst-Case Scenario – What if interest rates skyrocket?  If you can’t afford your loan’s maximum rate, you will probably lose your home.
  • When The ARM Rate Doesn’t Offer Enough Of A Discount – I’m not sure there’s a fast rule here, but you should demand a sizable discount for the added risk of taking on an adjustable rate mortgage.  A discount of 0.5% probably isn’t worth the risk whereas a discount of 1.5% probably is.

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