ARMs Good Fit for Short-Term Borrowers

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For months, ever since the economy started strengthening, experts have predicted that mortgage rates would start to rise. It just hasn’t happened because of a variety of factors.

Chief among those are worries over the Greek debt crisis, which has spurred demand for safe U.S. Treasury securities. High demand drives bond prices up, causing yields to fall, driving mortgage rates down. The 30-year fixed-rate mortgage is now sitting at about 5%, according to the BankingMyWay.com survey. That’s the lowest since early December.

That’s a terrific rate, and most borrowers are wise to lock that in for the long term. But borrowers with a short ownership horizon or a stomach for risk might take a look at two other products offering unusually good deals: five- and seven-year adjustable-rate loans.

These carry a fixed rate for the first five or seven years, then reset the rate according to market conditions, typically every 12 months. The five-year ARM averages just 4.069%, according to the survey. The search tool shows numerous lenders charging even less. The seven-year deals charge about the same, while providing two more years of protection against a rate hike.

According to HSH Associates, the mortgage data firm, the five-year ARM is the most popular alternative to the 30-year fixed-rate loan.

If you’re planning to stay put for the long term — 10 years or longer — the 30-year fixed-rate deal could well be best, as you won’t ever have to worry about paying a higher rate. But a five- or seven-year deal could be worth the gamble if you figure you’ll have the loan for only seven, eight or 10 years.

Imagine you wanted to borrow $300,000 and had a choice between a five-year ARM starting at 4% and a 30-year fixed loan charging 5%. Let’s assume that after the first five years the ARM rate would jump by 2 percentage points a year until it hit a lifetime cap of 10% — a worst-case scenario.

According to the ARM vs. Fixed-Rate Calculator, you’d be better off with the ARM if you expected to have the mortgage for less than 10 years and six months.

Assume the ARM rate hikes would be just 1 percentage point a year, to a cap of 10%, and the break even point would be 17 years and one month. That’s a powerful argument for considering the five-year ARM.

If you hit the “View Report” button you’ll also see that with the ARM you’d be paying down principal faster in the early years. Because less of your monthly payment would be needed for interest, more could go to principal. This benefit fades after the ARM rate exceeds the fixed rate, but it can be an added reason for choosing the ARM if you have a short ownership planned.

Of course, an ARM only makes sense if you can handle the bigger payments you might face someday. If your rate went to 10% in eight or 10 years, you might regret having passed up the 5% fixed-rate deal. But in eight or 10 years your income might be a good deal higher than it is now.

For peace of mind, the fixed-rate loan is hard to beat. But the five- and seven-year deals are worth a look. Be sure you know how that ARM adjustments would be calculated.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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