How to Lower Your Rate, Part 2: Look (Carefully) Into an ARM

Last week we discussed that one of the best ways to secure a low-interest rate on your mortgage, by buying “points” and essentially trading some cash-in-hand for a lower rate. This week, we take a look at another way you can guarantee yourself a lower rate: by using an adjustable-rate mortgage product. First, some definitions.

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The primary difference between a fixed-rate mortgage and an adjustable-rate mortgage is that a fixed-rate mortgage is just that – fixed, and not subject to the whims of the market for the duration of the loan, instead of an adjustable-rate product, which is only fixed for an initial period. While a fixed-rate mortgage protects you against future interest rate increases, you also don’t get to take advantage of a drop in rates. Now, while you may have read or heard bad things about adjustable-rate mortgages, particularly the explosion of their use during the “bubble” years of the early-to-mid 2000s, bear in mind that an adjustable-rate mortgage isn’t for everyone, and you should definitely do your homework and fully understand the implications before proceeding with one. For instance, many of the problems with ARMs during the foreclosure crisis stemmed from the fact that far too many ARMs were locked only for an extremely short time and far too few people understood how an ARM worked.

All that said, it is always a good idea to check and see if an ARM is right for you. A big factor to consider is how long you plan to stay in the home. If this your forever-dream-home you plan to live in for decades, then a fixed-rate loan is likely the best bet. However, if this is to be a short stay (think less than six or seven years), than locking in a low rate for a few years might be a great way to save money. A good example is a 5/1 ARM, which allows the borrower to lock in a lower rate (about 1% lower than a fixed-rate) for five years, after which your rate will reset once a year for the remaining 25 years. While it’s not guaranteed that your rate will increase after five years, it is a possibility, meaning it’s a good idea to plan to either sell or refinance into a fixed-rate before the end of the fifth year.