The popularity of adjustable rate mortgages (ARMs) rises and falls depending upon the overall direction of interest rates, as well as the spread between fixed rate mortgages and adjustables. There are many reasons why one might opt for an adjustable rate mortgage. In analyzing whether you might be a viable candidate for an adjustable, there are many facets you may want to consider before making a decision:
What is the current interest rate spread between a fixed rate and an adjustable? Fixed mortgage rates are based upon long-term interest rates while most adjustables are based upon short-term rates. For example, a one-year adjustable will typically be priced off current one year T bills. Short-term rates are typically lower than long-term rates, which is why adjustables will have starting rates below fixed rate loans. The difference between the two, the spread, is not always the same. If fixed rates are at 5.0% and a one-year adjustable starts at 2.0%, the benefit is clearly seen. If the adjustable starts at 4.5%, the choice is not so clear.
How long are you going to keep the mortgage? Note that the question here is not how long you live in the house. If you convert the home to rental property sometime in the future, you will still be making payments on the mortgage. Also, you may refinance the mortgage in the future and remain in the property. Factors that might affect your long-term use of the mortgage might be your job stability, mobility and the current interest rate of the mortgage. For example, if you purchase a home and obtain a mortgage during a period of relatively high mortgage rates, a refinance is more likely in the future. The average life of a mortgage in the United States ranges from five to seven years depending upon the economic and interest rate environment.
Which direction do you think mortgage rates will move? If you feel that the present level of rates is high and the movement is likely to be down, you are more likely to benefit from an ARM. Note that an opinion of the future of interest rates is just that — an opinion. Yet, if rates have recently moved up, they are more likely to move lower in the future.
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