Obviously, if the worst case scenario would raise monthly payments to a crippling level, the ARM should be avoided, even if the worst case seems fairly unlikely. But if you could survive the worst case, and you consider it unlikely anyway, it might be a risk worth taking. The scenarios involving more modest rate increases may be more likely, making the ARM a cheaper option than the fixed loan.
This is where some other factors come in. If your income is likely to rise significantly, the worst case may be a disappointment but not a calamity. But if your income could be unsteady, or you will have little job security, the worst case could be a much more serious risk.
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Of course, salary matters as well as job security. If you have plenty of disposable income and can easily cut back on spending to make a higher mortgage payment, the worst case interest rate on an ARM need not be such a big worry.
Also, ask yourself what kinds of returns you expect from your other investments. If the monthly savings from the ARM can be invested at a return higher than the mortgage rate, the ARM could be a good choice even under the worst case scenario.
Since your home is an investment, consider whether it will appreciate. A healthy rise in home prices would make it easier to sell your property to pay off the mortgage later on.
Finally, what is your stage of life? The risks of an ARM rate increase will be easier to shoulder if you will still be in your prime working years when it happens rather than if you will be retired and living on a fixed income.
If after exploring all these issues the ARM seems to make sense, but still makes you uneasy, don’t bother with it. By historical standards, fixed-loan rates are very low, and you probably wouldn’t regret locking in for the long term at under 5%, even if you could have saved a bit with an ARM.
Peace of mind is worth something, too, after all.
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