Is an Adjustable Mortgage with a Teaser Rate Always a Bad Idea?

By Gina Pogol
Mortgage Credit Problems Columnist

Dave Asks: Dear Gina, I am looking for a loan to refinance my home and I am confused. My current loan is an adjustable rate mortgage (ARM) and I planned to get another one. But I keep seeing articles from mortgage experts who say that these loans are bad and that I should always get a fixed rate loan. Is this true?

Featured Home Equity Loan Provider
    • Get your Free Quote in Minutes!
    • Lenders Compete for your Business
    • Lock in a Low Fixed Rate Before Rates Increase!
    • Do you have the Lowest Rate Possible? Find Out Instantly!

Gina Says:

Dear Dave,

ARM loans have been somewhat demonized recently by many because of the fallout from the mortgage crisis. And it's true that borrowers with ARMs have a much higher default rate than those with fixed rate loans. However, that's not the entire picture.

Toxic Loans - Option ARMs

The ARM products of the past included loans called option ARMs that allowed borrowers to choose what they paid each month--a low minimum payment that didn't cover the monthly interest and caused the loan balance to increase every time it was chosen, an interest-only payment that didn't pay down any principal balance, a fully-amortized 30-year payment, and an accelerated 15-year payment. People got into trouble when they chose to make only the minimum payments, month after month, and the balances of their mortgages increased until the loans became unmanageable.

Toxic Loans - Subprime ARMs

What happened with borrowers who took out sub-prime mortgages was similar. Many of these loans started out with reasonable rates, but after two or three years they might have adjusted five or more percent higher. They also came with huge penalties for repaying them within five years. So the borrowers were stuck with very expensive loans and payments they couldn't sustain. To make things worse, even those who might have refinanced out of their mortgages couldn't qualify when their home values dropped to less than the amount owed on their mortgages.

Today's ARM Loans: No Longer Poisonous

Your available ARM products today don't contain the time bombs of the loans of the past, and you could save some significant money by choosing one. The lower rate on an ARM can help you reach your financial goals, whether they be investing, paying your mortgage off early, or reducing your debt. Many of today's ARMs don't come with prepayment penalties, or they may be "soft" penalties, which only kick in if you refinance and not if you sell your home.

Today's ARMs: Timing Is Everything

Studies have shown that most people don't keep their homes for thirty years--in fact, first-timers keep theirs about three years and second-timers about five years. The National Association of Realtors claims that the average length of time all homeowners keep their properties is only six years. So why pay extra for a thirty year loan?

How Much Can You Save with an ARM Loan?

The rate on a hybrid ARM, with a rate fixed for the first five years, is about a full percent lower than its thirty-year counterpart. On a $400,000 loan at 5%, your payment is $2,147. With a 5/1 hybrid at 4%, your payment is $1,910, or $237 less. Over five years, that's $14,257! Use that money to pay down your mortgage faster, retire high-interest consumer debt, or channel it into an emergency fund. If you aren't planning to keep your mortgage much longer than five years, this is free money to you.

You probably saved a substantial amount by selecting an ARM loan when you bought your home. Choosing one for your refinance may be intelligent as well.



Get Quotes From Competing Companies

Loan Type:
Home Type:
Property State:
Credit Rating: