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Adjustable Rate Mortgages (ARMs) are the instrument that created massive problems for so many Americans. But is there ever a reason to get an ARM versus a traditional fixed rate loan? Are ARMs inherently risky or is it just certain types that had unrealistic teaser rates and negative amortization? It turns out that ARMs in of themselves haven't been a bad instrument in the last decade, it's those that had built in interest rate jumps that have caused so many issues.
And yet, most Americans would do well to stick with the traditional 15 or 30 year mortgage. They provide certainty that can be budgeted for and reduce the risk of any payment spikes in the future. However, the spread between a 30 year mortgage and a 5/1 ARM is about 100 basis points (1 percent). If you are in one of these 5 situations, it may be worth nabbing an ARM if the differential is great enough.
1) You Are Wealthy:
If you have far more in liquid assets than you are borrowing on your mortgage, and the gap between a fixed rate and variable rate mortgage is significant, you can stomach the variable rate risk. Your built up net worth allows you to take advantage of the cost savings all the while knowing that if interest rates spike, you'll be able to weather the storm or just decide to pay the loan off. There are numerous advantages for those with a solid net worth and taking calculated financial risks is definitely one of them.
2) You Have 7 or Fewer Years on Your Mortgage:
If you have only a few years left on your mortgage and you can find an adjustable rate mortgage (or even a HELOC) amortized over just a few short years at a much lower rate, it might make sense to make the switch. Why? Your interest rate savings will translate to you paying down your mortgage principal faster. If after a few years, interest rates spike, you will have already paid down more of the principal on your mortgage so the increase in interest payments will be muted. Only do this if you will actually pay down the principal at an accelerated pace. If you don't have the financial discipline to pay down the principal, stick with your existing mortgage as most of the payments you are making will be to principal.
3) You are Flipping a Property:
Flipping a property was all the rage a few years ago and few people do it today, but the ones that are still doing it are able to make decent short term gains picking up distressed properties. If you have no plans to keep a property and you are certain that you will not be underwater (i.e you are buying at a great price and you have 20% equity) you are a prime candidate for an ARM. Side comment about flipping. While all the rage a few years ago at exactly the wrong time, the people doing it today in a disciplined fashion are able to turn a profit even in a flat or slightly declining market. If they know what they are doing.