Are ARMs always bad?

Lately, a lot of press has talked about Adjustable Rate Mortgages (ARMs). Many in the finance industry have hailed these as as major reason for the collapse of the mortgage industry, and ultimately the economy. But is an ARM always a bad choice? Are there "good" ARMs and "bad" ARMS? Let's explore.

In a traditional mortgage, your interest rate is fixed at a certain percentage (right now probably in the 5s is a good estimate) for the life of the loan. That means for 30 years (perhaps 15) you are going to pay at a rate of 5% on the outstanding balance.

In an ARM, your rate is fixed for a period of time, and then after that period it is allowed to adjust. In the case of the "bad" ARMs they adjusted after a relatively short period, and had no caps. Additionally, lenders would qualify individuals based on the "teaser rate" (the low introductory rate), and have no thought as to the borrowers ability to pay should the rates rise. And rise they did...

Ok, that's the ARMs that were likely not good for many folks. However, there is an ARM out there that can be GREAT for a lot of folks. It is a Government Insured FHA 5/1 Loan. If rates on a fixed mortgage are at 5% right now, then let's say on the FHA ARM they are 3.75%. This means that for the first 5 years of your loan your interest rate is only 3.75%. Then after that the interest rate can only rise by 1%/year and only 5% over the life of the loan. So you'd be in year 7 before you'd even START paying at a higher rate than the fixed loan, not to mention the first 7 years were less expensive! AND THAT'S WORST CASE! There is a good chance it could stay well below that 5% for a long long time.

It's something to think about if you feel you'll be moving (as the average American does) in the next 4-8 years. If you plan on living in this house until it's paid off stick to the fixed rate. But if not, at least have a mortgage professional explain to you the benefits of such a loan. But, be sure to look at the worst case scenarios and make certain that should that happen you and your family are willing to handle the additional cost.

As always give me a shout with any questions or comments.