- The Washington Times - Thursday, January 20, 2011

Q.My wife and I are going to refinance before inflation kicks in and mortgage rates skyrocket. We’ve been hesitating because we thought there was a possibility we would sell our home in 2011. Now it appears we may remain in the Washington area for another five years.

I think we should refinance to an adjustable-rate mortgage (ARM) because we won’t be in the house forever. My wife thinks we should play it safe and take a fixed rate. Is it unwise for us to refinance to an ARM?

A. This is a subject that comes up a lot. Though I don’t make a habit of recommending ARMs, these products can be good for the right situation. Many of the new regulations and disclosures portray ARMs as dangerous products. Such a broad-based conclusion is unfounded, in my opinion. Let’s run some numbers on a simple example.

On a $300,000 loan, one might find a 30-year fixed rate of 5 percent with no closing costs. This would result in a principal-and-interest (P&I) payment of $1,610 per month. Refinancing to a 7/1 ARM might result in a rate of 4.25 percent, which would be fixed for the first seven years and might adjust thereafter. The P&I payment at this rate equals $1,476 - a difference of $134.

At the end of seven years, the 7/1 ARM would save the borrower $11,256 in payments. Moreover, because the rate is lower on the 7/1 ARM, it would curtail principal faster than the fixed rate. My calculator tells me the principal balance at the end of seven years would be $263,835 under the fixed-rate plan. Under the 7/1 ARM, the balance at the end of seven years would be $259,647.

At the end of seven years, the 7/1 ARM saves the borrower $11,256 in payments and adds an additional $4,188 in equity, a total financial benefit of $15,444.

So ARMs clearly are not always the evil products portrayed by the media. You need to ask yourself one simple question: How high is the probability of your selling your home within the next seven years? If you and your wife determine the probability is high, you should seriously consider taking the 7/1 ARM.

Remember that if, for some reason, you still have the ARM in year eight, when the rate can adjust, there’s no certainty the rate will adjust upward. Inflation may indeed kick in, but rates can rise and fall over a period of seven years.

One more thing: If you do have the ARM in year eight and the rate does indeed adjust up, you are still $15,444 ahead at the end of seven years. Rates would have to remain high, and you would have to not sell or refinance for a long time before you lost the $15,444 you gained during the first seven years of the loan.

Henry Savage is president of PMC Mortgage in Alexandria, Va. Send e-mail to henrysavage@pmcmortgage.com.

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