When to Get an Adjustable-Rate Mortgage

Adjustable rate mortgages were hot stuff a few years ago -- but that was then.

ARMs recently accounted for just 8.3% of new mortgage applications during the week ending May 9. That was up from 6.8% the week before, but down from a peak of around 34% in the first quarter of 2005, according to data from the Mortgage Bankers Association.

You can't blame consumers for their wariness. Most of us have heard stories about homeowners whose ARM payments skyrocketed when rates rose. And in fact, the misuse of ARMs helps account for the recent wave of foreclosures and a rising tide of wrecked consumer credit.

Nevertheless, there are still some situations where choosing an ARM over a fixed-rate mortgage makes sense for consumers -- in particular, those who are likely to move before (or soon after) their rate resets, and who know that they can weather potential rate hikes should their plans change.

Rates on ARMs tend to be lower than for fixed-rate loans because you take on the risk of rate increases later.

The average rate for a 5/1-year ARM (five years at a fixed rate, followed by rate adjustments every subsequent year) stands at 5.57% while the average rate for 30-year fixed loans is 6.01%, according to data from Freddie Mac(FRE Quote).

A 0.44-percentage-point difference in rates on a $200,000 loan translates into a $56.01 monthly savings. If your rate resets in five years, you could save $3,361 in mortgage payments ($56.01 x 60 months) during that initial period.