Why You Should Be Wary of the Five-Year and Other ARMs
By Jeff Brown
NEW YORK (MainStreet)--For several years we've suggested that borrowers with a stomach for risk take a look at the five-year adjustable-rate mortgage, which could be considerably cheaper than the standard 30-year fixed-rate loan that dominates the market.
But not anymore. Rising interest rates and a projected slowdown in home-price appreciation make the five-year and other ARMs too risky. For most borrowers, this is a time to lock in a long-term fixed rate -- and to congratulate themselves if rates rise down the road.
ARMs charge the advertised rate for the initial period of one to seven years, then adjust the rate every 12 months to rise or fall with market conditions. The initial rate is often substantially lower than the rate on fixed-rate loans, but there's a risk it will rise above the fixed rate down the road. Currently, the one-year ARM charges 2.75%, the three-year 3.68% and the five-year 3.23%. The 30-year fixed rate averages 4.3%.winding down programs to keep rates low. That increases the prospect that an ARM rate could rise after the initial period ends. ARMs typically limit rate changes to 2 percentage points a year and 6 points over the life of the loan. That means a five-year ARM that starts today at 3.2% could eventually charge more than 9%. Even with the 2-point annual cap, it could go to 5.2% after five years -- a full point higher than you'd be paying at that time if you'd locked in a fixed-rate loan today.
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