I’m finally ready to buy a house, but I’m confused about the right kind of mortgage to get. The guy I talked to at the bank said an adjustable mortgage was the way to go to save money, but I’ve heard bad things about them that make me nervous. Should I stick with a fixed mortgage?
Adjustable-rate mortgages, or ARMs, are commonly flaunted as the way to save the most money on your monthly payments. Tempting and arguably true, yes, but there’s a catch, of course. There are two kinds of ARMs: interest only (which offers the cheapest payment option) and fully amortizing (which is most common). ARMs, as the name indicates, feature rates -- and in turn, monthly payments -- that change after a specified period of time, such as three or five years. How much they can change depends on the status of a particular index the lender chooses (commonly a short-term treasury index or the LIBOR) and any potential “margin” and “cap” above the index. In some extreme cases, the rate on an ARM can ultimately double.
Fixed-rate mortgages, on the other hand, offer rate and payment security, but in exchange, you pay more per month. However, they almost always end up costing less over time versus ARMs and can save you a lot of worry and stress. See for yourself by doing the math here.
The only reason to consider an ARM is if you knew for sure you would only be living in your home for a short time and could easily sell it before your loan rate adjusts. In this case, an ARM could make sense and save you money (that you, of course, should be investing to really make it worthwhile!). Otherwise, the risks of payment inflation and overpaying in the long run are too great and should be avoided.
The bottom line on buying a home: Unless you can comfortably put 20 percent down on a home and afford a fixed-rate mortgage monthly payment, you probably shouldn’t buy it.