Of course, a rise that high would cause a dramatic increase in your monthly payment, so it would make no sense to get this ARM if you really thought rates would go that high and stay there. You'd be much better off getting today's 30-year, fixed-rate loan, averaging 3.5%.
This means the best candidate for an ARM is the borrower who expects to pay off the loan during the initial period, such as five, seven or 10 years, while the rate is fixed.
This would include one who is buying a home that is likely to be sold during that period.
It would also include a homebuyer, or a homeowner who is refinancing an older mortgage with a high rate, who is capable of making
to retire the loan ahead of schedule.
A homeowner who is refinancing, for instance, may have already reduced the original loan balance substantially. With a lower interest rate on the ARM and a modest loan balance, it might be possible to pay off the new ARM during the initial period with a monthly payment similar to that of the old loan.
In the same way, a buyer with plenty of resources could make extra principal payments to pay the loan off while the rate remains low.
Even if these borrowers failed to retire the debt during that initial period, reducing the debt through extra payments would reduce the pain if the rate did rise in the future. Check your numbers with
The key, then, to making an ARM work: Be sure you can afford the payment at the maximum rate the ARM could charge, or make extra payments so you never face a burdensome payment.