ARMs Still Have Their Place

NEW YORK (TheStreet) -- Adjustable-rate mortgages have been in Siberia for a few years, accounting for only a smidgen of new loans. But certain borrowers should now take a look, as ARMs currently charge significantly less than loans with fixed rates.

Just before the start of the financial crisis in 2007, the three-year ARM rate was about 6%, nearly identical to the rates on 30-year fixed-rate loans. Though the spread widened somewhat as rates fell in the years that followed, fixed-rate loans charged so little that the vast majority of borrowers chose their predictability over the risk of future rate increases they faced with adjustable-rate loans. ARMs typically reset every year after the initial period ends.

But things have changed. In November 2012, the average 30-year fixed loan charged 3.66% and the 3/1 charged ARM 3%. That 0.66-point gap has since widened to 1.5 points, with the fixed loan at 4.6% versus the ARM's 3.1%. For every $100,000 borrowed, the fixed loan would charge $513 a month, the ARM $427.

The ARM would save the borrower nearly $3,100 during the three years its rate was guaranteed, or $9,300 on a $300,000 loan. That's enough to get you thinking.

Also, the lower rate would allow more of each ARM payment to go to principal, so that after three years the balance on the $100,000 loan would be $94,645, versus $95,109 on the fixed loan.

There is, of course, the standard downside of ARMs: the risk that the annual rate resets that start after three years would leave the borrower paying more than with the fixed loan. For the fourth and fifth year, higher ARM payments might merely erase some of the first three years' savings, but eventually the net cost of the ARM could well be higher. The bigger the rate hike, the sooner that would happen.

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