As one of the greatest investments you may ever make, there has always been an element of risk associated with any mortgage. Fail to pay off your mortgage and you could lose your home.
With fixed rate mortgages, the risk stays the same. You make the same payment at regularly scheduled intervals throughout the life of a typical 15- or 30-year mortgage. With adjustable rate mortgages (ARMs) the rate of interest you pay on the loan will change after a certain number of years, depending on current market rates and economic trends.
If you have taken out an ARM you are essentially taking a gamble; hoping that interest rates will be lower when your interest rates changes. If the rates go up you’ll face higher monthly payments and be on the losing side of the gamble. If rates go up too high you may be priced right out of your home.
ARMS are quite popular alternatives to fixed rate loans. Interest rates have remained very low for several years and many consumers have been content to accept the risk of rising rates. In 2006 this could change. Our exploding trade deficit, rise in oil prices, costly wars around the world and the unprecedented devastation of the Gulf Coast caused by hurricane Katrina are having a very negative impact on the economy of the United States.
Despite the grim economic forecast, rates may be kept low to encourage consumers to do what they do best – spend money. There are a lot of long-term factors you’ll want to consider when making the decision to go with either a fixed rate or ARM.
The most common ARMs available to consumers are 5/1 ARMs and 3/3 ARMs. With a 5/1 ARM you will have the same interest rate for the first 5 years of your loan, followed by annual interest fluctuations. With a 3/3 ARM your interest rate will fluctuate once every 3 years.
An ARM may be an excellent alternative if you plan to sell your home before your interest rate changes. Introductory interest rates are usually very low with an ARM. If interest rates go up too high, however, you may not be able to sell your home in time to avoid a higher interest rate.
Another type of loan similar to an ARM that may be even more risky to your finances is known as a “balloon mortgage.” With a balloon mortgage you will pay a very low interest rate for 5 – 7 years. At the end of that period the entire loan balance must be paid. If you haven’t sold your home by the time the loan becomes due in full you could face foreclosure and lose your home.
The only way to free yourself from a balloon mortgage or ARM is to refinance your loan at a fixed interest rate. The costs of a refi could eat away at any potential short-term cost savings you may gain from these variable rate loans.
Planning ahead is essential to getting the most out of your mortgage. If you decide to gamble on the greater risks associated with ARMs make sure you’re making an educated decision. The true costs of your loan could impact your financial future for years to come.
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John Campbell is the writer and editor of CashBuzz, A financial portal for the rest of us. Check out cashbuzz.com for the latest articles on money management and tips and tricks that can help improve your finances. This article may be reprinted on your Web site if the copyright, author information, and active link are included.
