The Pros and Cons of Adjustable Rate Mortgage Loans

An adjustable rate mortgage can be enticing to any new homeowner. After all of the other expenses that go along with buying a home, why not try to save some extra cash every month? ARM, also sometimes called variable rate mortgage, can be beneficial but you must know the pros and cons, and how to make it work for you and not against you.

ARM offers lower monthly mortgage payments for a period of usually three to five years. Most likely you have seen this as "3/1" or "5/1." This means you have a lower rate for those first few years, but then it can adjust every year thereafter depending on certain economic indicators. The adjustable rate mortgage is good for those homeowners who are sure their monthly income will increase within the introductory period or those who could greatly benefit from the up front savings.

But with the good come the bad. Once your three or five year rate expires, the increase could be detrimental if you’re not prepared. The increase may force you to refinance (which is not always a bad thing since it depends on the market), take out a second mortgage, or use your home equity line of credit to not fall behind. If you are in this situation, your best option is to use your home equity line of credit, especially in the market today. Unlike taking out a second mortgage (also frequently called a home equity loan or home improvement loan), your line of credit is just that. It is a predetermined amount of money, based on your home’s value, that is reusable once paid back. The increased rate could also postpone retirement or force a foreclosure.

The opposite of an adjustable rate is a fixed rate. This kind of mortgage ensures the same payment every month for the duration of your loan. You have to be careful with a fixed rate mortgage because it all depends on the market at the time you purchase your home. There is a lull in the market right now and people are selling because their payments are too much. About five years ago the real estate boom allowed millions of people to afford home loans and refinancing loans, but on risky terms which included adjustable rates. The five year introductory period is about to lapse and a large percentage of homeowners are at risk. According to Noelle Knox: "Of the 7.7 million households who took out ARMs over the past two years to buy or refinance, up to 1 million could lose their homes through foreclosure over the next five years because they won't be able to afford their mortgage payments, and their homes will be worth less than they owe...."

So what can we conclude about the pros and cons of adjustable rate mortgages? First and foremost, it is a risk. Although you may be told that after the first few years the rate may go up or down, don’t fool yourself by thinking it will probably go down. It is important to plan for raised rates by keeping a savings account which will help with some extra costs until you figure out another way to make the higher payment. According to the US Census, 28% of Californian adults do not have a savings or checking account. Nationally, 10% of all households do not have an account either.

Why are working families not able to construct a savings account for an emergency? One reason is that credit card debt is out of control. It is easier and easier to get approved for a credit card, but the spender needs to be responsible and exercise control. Another reason is special circumstances such as a death in the family, severe injury, or an unexpected layoff. The last reason is our out of control spending. Because we are in a country that prides itself on material things, many people spend all the money the bring in. For these reasons, and probably a few less common ones as well, ARMs are affecting homeowner’s lives in ways they are not prepared for. This lack of preparation can be destructing to your credit score, future business ventures, emotional state, and family relations.

Adjustable rate mortgages are a valuable way to save money if you are prepared for a raised rate after a few years. You must make the ARM work for you, to help your financial situation, but do not let it burry you in more debt and possibly foreclosure. The good can outweigh the bad but really it is on a case by case basis. Here are some things to consider before deciding for or against the ARM:

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  1. How steady is your job? Are you expecting a promotion?
  2. How long to you plan to live in your home?
  3. Are you getting married and joining incomes? Are you planning on starting a family in the near future?
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  4. Would you have an adequate savings to cover the difference in the case of a raised rate?
  5. How much money will you actually be saving by doing an ARM?
  6. How much other debt do you have? Would you be willing to use the equity on your home to pay off some debt if the mortgage payments were too much to handle?
  7. What is the real estate market like right now? What are the lowest and highest rates you could get? Talk with an expert and be realistic!

Answering these questions may be tough, but it could end up saving you in the future. Add your own questions and give genuine time, thought, and effort into answering them with the ones closest to you. Adjustable rate mortgages can help you get on your feet and with all the extra money you save in the beginning, why not put that into a savings for later? ARM holds you responsible for fluctuations in the economy, but if you are prepared and the benefits outweigh the costs, it can be a lifesaver.

Noelle Knox."ARMs Squeeze Homeowners." USA Today, 4/3/06.

Amy Condensa is an experienced writer who focuses on home loan financing. You can read more of her mortgage finance related articles at http://www.nationwidemortgages.net/ and get more information about home equity loans and mortgage refinancing. For a complete look at home equity loans please go to http://www.nationwidemortgages.net/home_refinance.html
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