Should you avoid adjustable rate mortgages?

Q: Is it best to avoid an adjustable rate mortgage?

A: Adjustable rate mortgages, or ARMs, offer less stability than fixed-rate loans because they fluctuate with the market. Monthly payments increase if an ARM is adjusted upward, and that’s too much risk for a lot of people to take. But if rates drop dramatically, homeowners can reap the benefits of lower rates without refinancing, saving thousands of dollars in the process.

ARMs were first introduced by lenders in the 1980s when interest rates soared into the double digits, forcing many people out of the home buying market. They tied the rate to a variable national index, like U.S. Treasury bills.

Today, many first-time buyers who have difficulty qualifying for a home loan still settle for adjustable rate loans because the initial, “teaser” interest rate of the mortgage is normally two or three points lower than a fixed rate loan. ARMs are particularly attractive if you plan to be in your home a short time. They tend to adjust yearly or every three years, usually within certain limits, or caps, that prohibit the interest rate from shooting up too high. Make sure terms such as these are spelled out in any ARM agreement you choose. 

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