ARMs worth a look for on-the-go borrowers
By Holden Lewis • Bankrate.com

Adjustable-rate mortgages wax and wane in popularity as the economic tides ebb and flow. Only about 11 percent of borrowers have been getting ARMs lately, and some experts believe more borrowers should consider them -- especially borrowers who expect to move within the next few years.

Adjustable-rate mortgages are home loans in which the interest rate changes periodically, rising or falling with an index. Lenders offer a wide variety of ARMs. Among the most popular are one-year ARMs, in which the initial interest rate changes after one year and then is adjusted every year thereafter; and 3/1 and 5/1 ARMs, in which the initial rate changes after three or five years, then is adjusted annually.

ARMs appeal to borrowers because of their lower rates. In Bankrate.com's recent survey of mortgage rates in the top 10 markets, the national average for a 30-year fixed-rate mortgage was 6.70 percent. The national average for a one-year ARM was 5.67 percent. A recent national average for 5/1 ARMs was 5.76 percent.

If you borrowed $150,000 at those rates, your principal and interest for the 30-year fixed loan would be $967.92 a month. For the one-year ARM it would be $867.75 (and it would probably go up a year later), based on a 30-year payoff period. For the 5/1 ARM, principal and interest would cost $876.31 a month for five years.

If you got the 5/1 ARM instead of the 30-year fixed, you would save $5,496.60 over the first five years. Then the rate probably would go up.

When borrowers take out adjustable-rate mortgages, they're placing bets: that rates will drop significantly (not likely with today's low rates) or that they won't live in the house much longer than the initial rate period. For some people, the latter bet might be a good one.

According to the U.S. Census, half of homeowners live in their houses less than 8.2 years.

"The average person does not live in their house for 15 or 30 years, so anybody who is representative of the average should use adjustable-rate products to finance their home and not fixed-rate products," says Larry Goldstone, president of Thornburg Mortgage in Santa Fe, N.M.

You would expect Goldstone to make that argument because his company specializes in a bewildering variety of adjustable-rate mortgages. He makes a living by persuading people to choose ARMs, and, judging from a telephone interview, he's an excellent salesman.

Goldstone isn't alone in believing that ARMs are about to become more popular. Ken Mayland, president of ClearView Economics in Pepper Pike, Ohio, says ARMs are increasingly attractive because the Federal Reserve continues to cut short-term interest rates.

How ARMs adjust
ARMs usually are tied to an index of shorter-term interest rates. Most are set at a certain number of percentage points higher than rates for one-year Treasury notes, the 11th District Cost of Funds or other indexes such as the LIBOR. You can see these other rates here. Since the Federal Reserve has been cutting short-term interest all year, the rates for ARMs are low.

They are not, however, absurdly attractive right now compared to rates for 30-year fixed loans. Over the past 16 years, the difference between 30-year fixed rates and one-year ARMs has averaged a shade under 2 percentage points. Now the spread is just 1 percentage point.

Mayland expects lenders to market ARMs more aggressively in the coming months, and that might mean they'll offer bigger spreads. With interest rates so low right now, they have no place to go but up -- and lenders don't want to get stuck lending money at low rates for 30 years when they can lend at rates that can adjust upward in one or three or five or more years.

"As bank marketing departments discover the current market situation and incorporate that into their marketing, I suspect the ARM is going to become a viable and touted product," Mayland says.

Just remember that when you borrow using an adjustable-rate mortgage, the lender is gambling that you'll stay in your house a while. The lender is guessing.

You, on the other hand, probably have a better idea how long you will stay in the house. Perhaps you know your company will transfer you in a few years; maybe you plan to have children; or your kids are about to move out, so you'll need a bigger or smaller house. Yes, you're gambling, just as your lender is -- but you're playing with a stacked deck.