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When to Get an Adjustable-Rate Mortgage

ARMs are out of vogue now that credit is tough to get. But there are times when they can be useful.

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



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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.

The catch? Given that rates are currently at or close to historic lows, there is a good chance that rates will adjust upwards after that.

Before signing up for an ARM, you need to be sure that you can weather a worst-case scenario. Almost all ARMs have a lifetime cap, which limits how high the rate can go over the life of the loan (such caps typically are set at around 12% today). You should also be sure that your ARM has a periodic adjustment cap, which limits each rate hike (often to around 2%).

Ask yourself how you would fare if the rate on your loan hit its ceiling. Remember you have $3,361 set aside (hopefully earning a decent return) that you can use to help weather higher payments. So even if you move after six or seven years, you may still come out ahead with an ARM.

That said, ARMs probably aren't a good idea if you are likely to stay in your home for the long term, or if you have any trouble making the initial payment on your loan. In the leadup to the credit crisis, many buyers used ARMs to buy houses they couldn't otherwise afford -- and they are suffering now.

"People were asking what is the smallest amount per month that it will take to get me into this house," explains Jay Brinkermann, chief economist for the Mortgage Bankers Association. "They didn't have the financial flexibility to cope when the rates adjusted."

The bottom line: The benefit of a fixed rate mortgage is that you know what you will pay each month for the next 30 years. But if calculate that you are moving before the rate resets or that you can handle the worst-case scenario, then you may want to consider an ARM.

Check the mortgage section of for some of the latest offers of ARMs in your area.

Peter McDougall is a freelance writer who lives in Freeport, Maine, with his wife and their dog.