Adjustable-Rate Mortgages - For Marginal or Savy Home Buyers?

According to this article in Real Estate Weekly (free subscription required) adjustable-rate mortgages (ARMs) may be the tool of smart buyers, not marginal buyers as previously thought.

Adjustable-rate mortgages have been maligned in recent years as some critics have contended that, in an era when fixed-rate loans were at historic lows, ARMs were only being used by marginal buyers who could not otherwise afford to buy houses. The implication was these were all risky loans that would eventually come back to haunt lenders and the housing market.

But ARMs account for about 32% of all home loans while 30-year fixed rates have remained low. Why? The article points out that if you are not planning on staying in your home for more than 5 years then why not take the lowest possible interest rate. People are not planning on buying a home and staying for 20 or 30 years so instead of locking in for 30 years they instead are opting for the ARMs.

This idea of better matching your housing plans to the financing you put on the housing is a relatively new one, since these hybrid ARMs — you can find three-year, seven-year and 10-year versions as well — have only been around a few years. (Freddie Mac only began tracking the 5/1 hybrid rate in 2005.) But the practice makes perfect sense: Homes turn over in the U.S. every seven years on average and first-time buyers especially often plan a short stay in their “starter” home before moving up. Even if your savings on a hybrid ARM is only a few tenths of a percentage point versus a 30-year loan, that’s money that can be in your pocket instead of the lender’s in those five years, as much as $760 on a $200,000 loan, Freddie Mac says.

But buyer beware:

That doesn’t mean there is no risk in these loans. Plans can change and adjustments can sneak up on you. If rates do spike, refinancing your way out of the ARM might not be of any help. But for the most part, this use of hybrid ARMs looks like a perfectly rational consumer behavior.