The Risks of an A.R.M.
If you're at all considering an ARM (Adjustable Rate Mortgage), you absolutely, positively must understand what
rising interest rates (and, therefore, a rising monthly mortgage payment) would do to your
personal finances. Only consider taking an ARM if you can answer all of the following
questions in the affirmative:
- Is your monthly budget such that you can afford higher mortgage payments and still
accomplish other financial goals that are important to you, such as saving for retirement?
- Do you have an emergency reserve (equal to at least six-months' living expenses) that
you can tap in order to make the potentially higher monthly mortgage payments?
- Can you afford the highest payment allowed on the adjustable-rate mortgage?
The mortgage lender can tell you the highest possible monthly payment, which is
the payment that you would owe if the interest rate on your ARM went to the lifetime
interest-rate cap allowed on the loan.
- If you are stretching to borrow near the maximum the lender allows or an amount that
will test the limits of your budget, are your job and income stable?
If you expect to be having children in the future, consider now the fact that your
household expenses will rise and your income may fall with the arrival of those little
bundles of joy.
- Can you handle the psychological stress of changing interest rates and mortgage
If you are fiscally positioned to take on the financial risks inherent to an
adjustable-rate mortgage, by all means consider taking one -- we're not trying to talk you
into a fixed-rate loan. The odds are with you to save money, in the form of lower interest
charges and payments, with an ARM. Your interest rate starts lower (and stays lower, if
the overall level of interest rates doesn't change). Even if rates do go up, as they are
sometimes prone to do, they will surely come back down. So, if you can stick with your ARM
through times of high and low interest rates, you should still come out ahead.
Also recognize that, although ARMs do carry the risk of a fluctuating interest rate,
almost all adjustable-rate loans limit, or cap, the rise in the interest rate
allowed on your loan. We certainly wouldn't allow you take an ARM without caps. Typical
caps are 2 percent per year and 6 percent over the life of the loan.
Consider an adjustable-rate mortgage only if you're financially and emotionally secure
enough to handle the maximum possible payments over an extended period of time. ARMs work
best for borrowers who take out smaller loans than they are qualified for or who are
consistently saving more than 10 percent of their monthly income. If you do choose an ARM,
make sure that you have a significant cash cushion that is accessible in the event that
rates go up. Don't take an adjustable just because the initially lower interest rate
allows you to afford a more expensive home. Better to buy a home that you can afford with
a fixed-rate mortgage.
This Homebuyers Tip was excerpted from
Home Buying For Dummies, by Eric Tyson, Ray Brown. © 1997 by Eric Tyson, Ray Brown,
used by permission of IDG Books.