04 May 2007

I have an ARM. So what?

Jim over at Blueprint for Financial Prosperity published a devil's advocate piece on adjustible rate mortgages. It was written by Colin Robertson of The Truth About Mortgage.

ARMs are taking a beating right now in the media. There are too many people out there that took out an ARM in order to get into a house they couldn't afford otherwise, saving some bucks every month on interest for the short term and not really considering what would happen when that term ran out. Big Surprise! Foreclosure after foreclosure as the fixed periods on the loan run out.

Like most other financial products, however, there is a right way to use an ARM. In the second paragraph of his Devil's Advocate post, in fact, Colin outlines one such circumstance:

Considering the average time people spend in a home is roughly three or four years, why settle for a high-priced fixed mortgage? You can get a 5, 7, or 10 year hybrid arm that comes with a significantly lower interest rate, plus the safety of a fixed period for longer than you’ll likely stay in the home.
Colin spends most of the blog being a smartass (which I can appreciate), but this is precisely why I got an ARM. I am living in what you might call a "starter home." It's in a neighborhood with only 3 or 4 floorplans and small houses and is peopled largely with young families and retirees. I purchased the house because it was a financial step up from renting (at least where I live) and because I was ready for the responsibility (and perks) of being a homeowner. I knew going in, as I know now 2 years into my 5 + 1 ARM, that there is no way I will end the fixed portion of my mortgage in this house.

What did it save me? Well, it's often claimed that an ARM doesn't make sense when fixed mortgage rates are low. They were pretty low when I got my mortgage; I could have gotten 5.4% from my credit union. Instead I got the 5 +1 ARM at a rate of 5%. Not much difference, right? Well, that depends on your definition of "not much."

Being a "starter home," my house was not expensive, and I live in an inexpensive area for homes as well. My mortgage after down payment was about $111,000. So how much difference does 0.4% make on a loan that small? 2 years into the loan, I've saved almost $1,000 in interest. That may seem trivial compared to the value of the loan, but $1,000 is $1,000. If you could save $500 per year with no trouble, you'd do it, right?

By the end of the 5-year fixed portion of the loan, the difference is about $3,000. I probably won't be in the house for another year, much less 3, so my real savings will be less than that. But money is money, and that's cash I can put in my Roth IRA or use to pay down my car loan. Here's the kicker, though . . . if I had to stay in the house past 5 years, I could afford the increased payment. I knew that going in and I wouldn't have gotten an ARM otherwise. That is where too many people dropped the ball.

Like everything, an ARM has its place. In my case, it has saved me $1,000 and counting. But for thousands of other Americans, it has been misunderstood, misused, and abused, and many people are now in big trouble. The bottom line? Don't bite off more than you can chew. If it adds up in your favor, go ahead and use the riskier ARM. Just be sure you can handle it if things don't go as you expect. Do your homework. Use common sense.

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