Is an ARM Right for You?

After all but disappearing after the housing bust, adjustable-rate mortgage activity is on the rise. The number of borrowers taking adjustable-rate mortgages, which typically carry a low fixed rate for one to 10 years and then adjust annually based on current rates, has jumped 75% since last year.

It’s no wonder with five year ARM rates a mere 3.69 percent vs. 4.99 percent for a 30-year fixed rate loan. Getting that ARM could save you $230 on monthly mortgage payments and more than $19,000 in interest during the first five years on a $300,000 loan.

According to the most recent Mortgage Bankers Association (MBA) Weekly Mortgage Applications Survey, although the number of refinance applications decreased 5.7 percent from the previous week, the adjustable-rate mortgage (ARM) share of the market increased to 6.2 percent from 5.8 percent from the previous week.

Consumers looking to reduce their monthly mortgage payments to pay down their personal debt or to increase their disposable income through refinancing can be a real plus for the economy. But even with current low buying and refinancing rates, consumers are still advised to carefully weigh out the pros and cons of an adjustable-rate mortgage to determine if it’s right for them.

If you've been temporarily relocated by your employer and know for certain you will moving in the short term, a three or five-year ARM makes sense. Or if you're in a starter home and think you're going to move to a larger home but aren't sure of the timing – a seven-year ARM could work for you.

But people tend to stay in their homes longer than they think they will. According to the National Association of Realtors, home sellers typically live in their homes for eight years, partly because it can take a while to sell a home now.

No one wants to get stuck with a payment they can't afford after the rate adjusts, so taking on a 5 year adjustable-rate mortgage with the thought you will refinance later at a fixed rate may cost you more money in the long run.

For example if you took a 5/1 ARM at 3.69% on a $300,000 loan and refinanced to a 6% fixed loan in five years, you'd pay $86,300 more in interest over the full term of the loan than if you took the 4.99% 30-year fixed loan today.

With the 30-year fixed rate at its lowest since November 2010, and the Mortgage Bankers Association predicting 30-year fixed rates will hit 6 percent by the fourth quarter of 2012 and climb higher the year after, locking in at a low fixed rate now may be your best option.