ARMs Still a Popular Choice for Many Borrowers

In the aftermath of the financial crisis, the 30-year fixed-rate mortgage loan, with near-low interest rates, has earned its reputation as the sensible choice. But even with attractively low fixed rate financing, adjustable-rate loans are still a popular choice for some borrowers. The market share of ARMs, in the first quarter of 2011, actually rose to 12 percent, the highest point since mid-2008.

Adjustable rate mortgages are generally more attractive to home borrowers when interest rates are high. You can get a lower mortgage rate set for one, five or seven years and then the rate adjusts to the prevailing rates within boundaries. That generally means the mortgage payment rates can go up. But borrowers who took out ARMs five to seven years ago are finding that the rates can also go down. Short of Japan-style negative rates, it’s tough to imagine how rates could get much lower than now.

“If a person is debt-averse and has a history of paying off his or her mortgage within 5 to 10 years, then he or she would definitely consider an ARM,” said Sari Rosenberg, a NY loan broker. “I have another client who knows he is selling his home within the next few years and even with the closing costs he will be saving money,” so he took out a three-year ARM.

“ARMs are good for borrowers with short-term time frames, usually seven years or less,” said Keith Gumbinger, VP of HSH Associates, a financial publisher. “This can include certain first-time borrowers who expect to trade up, such as a single person buying a studio apartment; folks who get transferred, or expect to be, within that time; folks refinancing with just a few more years expected in the old suburban mansion; jumbo mortgage seekers looking for a lower-cost alternative, and even folks who are approaching retirement age who want to seriously improve their cash flow to maximize their retirement accounts.”

On the other side, ARMs aren’t wise for borrowers who plan to stay put, or those who would have trouble handling rising mortgage payments. That includes borrowers who expect future cash-flow strains, such as those starting a family according to Gumbinger.

Borrowers with five or seven-year ARMs that are now resetting face another choice, according Gary Schatsky, a financial planner at Objective Advice. The 30-year fixed-rate loans are around 4.5 percent, on average, and ARM rates may drop to 2.25 percent to 3.25 percent from about 5 percent. But that super-low ARM rate is good for only a year.

“It’s very seductive,” Mr. Schatsky said, especially because keeping that ARM rather than refinancing into a fixed-rate loan avoids closing costs. If that’s the case, he said, know how much your rate could jump after a year — ARMs generally have caps on increases — and whether you can handle that.

Borrowers should consider using the savings from an ARM to pay down the loan, rather than spending the savings, Schatsky counsels, and borrowers who are nervous about higher future payments should consider forgoing the alluring new rate.

“If you have no room subjectively for the risk,” Mr. Schatsky said, “it’s not a bad time to say it’s been a good ride, but it’s time to go from adjustable to fixed.”