With all of the media reports about how bad ARMs and exotic mortgages are, you would first jump to the conclusion that Fixed Rate Mortgages (FRMs) are clearly the better deal. I am sure you have seen the reports of the subprime woes and how many families have been forced into foreclosure due to these types of loans either resetting or recasting. With all of the bad news out there, how could ARMs possibly be worthwhile?
The answer may surprise you. ARMs and exotic mortgages, including the Option ARMs (you know, the ones that everyone hate now), do have their benefits and they may be the best choice for you. The bottom line is that the answer to the question truly depends on your unique situation.
So, let's look at some facts. The average homeowner only keeps their mortgage for about 4 1/2 years and rarely stays in their home longer than 7 years these days. This is where ARMs truly benefit the homeowner, offering lower interest rates that are fixed for up to 10 years. Granted, with the yield curve remaining relatively flat, their benefits are not as good as they could be and current pricing on a 10/1 ARM is really not any better than a 30 Year Fixed.. Still, from a net worth standpoint, 5 years from now, based on today's rates, a homeowner who opts for a 5/1 ARM over a 30 Year Fixed and uses IO on both of them, will be ahead by thousands of dollars. As the yield curve returns to a more normal pattern, ARMs will offer better benefits as the interest rate spreads will be greater.
Of course, if you "plan" to stay in your home for a long time, fixed rate mortgages may be more beneficial, especially in today's market. But, be careful basing everything solely on emotions and your "plans". Things change and 5 years creates plenty of opportunities for you to change your mind or your financial picture changes enough your current mortgage no longer works for you. I moved into my current home 5 years ago and thought I would never move. I am getting the "itch" now though. So, even with plans for staying in the home for a long time, ARMs are worth looking at.
Another aspect you have to factor in is your risk tolerance. Yes, how much risk you are willing to take, just like with your investments, is a determining factor. If you are ultra conservative, go fixed and forget it. If you don't mind a little risk in order to reap the rewards, ARMs are definitely a viable option.
What about the Option ARMs? Well, this is where the picture gets a little different. I like these products for some as they present great opportunities to use your cash elsewhere. They are also great for investors who need to maximize cash flow and understand the loan programs. If you decide on these programs, you need to be disciplined enough to use the savings wisely.
One Option you may think about instead of doing the Option ARM is to get a Interest Only loan and a HELOC to start. You could then theoretically use the HELOC to offset the payment, in essence doing what the Option ARM allows for, but paying less interest since the amount starts small on the HELOC versus paying interest on a large amount to start off with. There may be limitations to your ability to do this.
As you can see, for most homeowners, ARMs are at least worth taking a look at. They provide smaller payments in general and the ability to focus more on investments or other NEEDED items first. Depending on your situation, risk tolerance, and other factors, they present the best option for most homeowners. Worst case scenario is they are going to reset before you move. Is that really that big of a deal? No. Chances are, your mortgage would need to be changed by now to be better integrated with your current financial plan or you are already planning to move.
So, the real answer is that it depends on your specific situation and needs. Both have their pros and cons and each must be looked at as a viable option. Overall, ARMs provide some benefits for the savvy homeowner, but do carry some risks as well. Get with your mortgage planning professional to see which one truly fits you the best.
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