When an adjustable-rate mortgage is the smart choice

Posted on July 17 By Peter Andrew

American consumers are uniquely lucky when it comes to mortgages. A 2010 paper by Dr. Michael Lea of San Diego State University revealed that no other advanced nation offers so many long-term fixed-rate mortgages, and in many countries (including Australia, Ireland, Spain, and the UK) they don't exist at all.

Why fixed-rate mortgages are great

The advantages of long-term fixed-rate mortgages (FRMs) are obvious: You have absolute certainty that every monthly payment you make is going to be exactly the same as all the others. It doesn't matter much to you if mortgage rates go up; your rate will stay the same until you refinance, move home, or finally pay off the loan.

Even though rates are generally on an upward trend right now, a glance at Freddie Mac's archive will show you how attractive they still are. And if you're lucky enough to sign a home loan deal when mortgage rates are near historic lows, you can enjoy affordable housing for 30 straight years.

Why adjustable-rate mortgages are sometimes better

So far, it sounds as if people would be crazy to opt for adjustable-rate mortgages (ARMs). But there are circumstances when that would be the smart choice. Indeed, toward the end of June, Richard Green used his Forbes blog to predict the ARM share of the overall mortgage market was set to increase significantly.

Three factors can sometimes make ARMs attractive:

  • ARMs can be flexible. So-called "hybrid-ARMs" offer an initial period when the rate is fixed -- often one, five or seven years. The rate floats only after that period ends.
  • ARMs tend to be cheaper than FRMs. During the week ending July 3, Freddie Mac reported that the average rate for a 30-year FRM was 4.29 percent with an average 0.7 point. The same figures for a 5-year Treasury-indexed hybrid ARM were 3.10 percent with the same point. You can use a mortgage calculator to see what that difference would mean to you.
  • ARMs can save you money. There's no point in paying extra for the security of a 30-year loan if you're likely to move again in a few years.

When it comes to choosing between an ARM and a FRM, that last point is critical, especially in the current market when mortgage rates remain so low. In December 2012, the U.S. Census reported that, based on information contained in the Current Population survey of 2010, 100.2 million Americans aged 5 years or over lived in a different residence five years previously. Some of them must have moved repeatedly during that time; but even ignoring that, it means that close to one in three Americans move at least once every five years.

7 events that may make an ARM the smart choice

For people that move this frequently, paying more for a 30-year FRM makes no sense. The difficulty is in knowing if and when you are going to move again. The American Moving & Storage Association categorized the circumstances that change housing needs as:

  • New job complicates your commute.
  • New job requires relocation.
  • Growing family requires a larger home.
  • Empty nest allows for a smaller home.
  • Neighborhood or school district changes.
  • Marital status changes.
  • Career status changes.

Looking into the future is always a difficult proposition. Nobody can predict how many kids they are going to have or when, whether they are going to have to change jobs, or whether an elderly relative will need to move in. But if you can make intelligent, informed guesses about what your future holds -- and are prepared to live with the consequences if you're wrong -- you might save tens of thousands of dollars by making a smart choice between an ARM and a FRM.

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