- The Washington Times - Monday, March 15, 2004

When Meredith Klein bought her first home earlier this month, she decided against a traditional fixed-rate mortgage.

Instead, she chose to buy the three-bedroom colonial in Lynn, Mass., with an adjustable-rate mortgage, or ARM. Her interest rate of 4.375 percent is locked in for five years but will rise or fall with the market after that.

Even with interest rates near 40-year lows, almost one in five borrowers is opting for an ARM instead of a fixed-rate loan, for which the interest payment can be locked in for up to 30 years, according to the Mortgage Bankers Association of America.

ARMs have been getting more attention since Federal Reserve Chairman Alan Greenspan suggested in a speech last month that Americans were not necessarily best served by fixed-rate loans.

He noted that home buyers pay a premium of as much as 1.2 percentage points to get a mortgage rate locked in for 15 or 30 years. If their mortgage rates had adjusted downward during the past decade as rates fell, “homeowners might have saved tens of thousands of dollars,” he said.

Although ARMs are riskier in a rising-rate environment — and the Federal Reserve is expected to begin raising rates later this year — there are some cases in which they make sense.

For Miss Klein, 28, who works as a fund-raiser for the nonprofit Raw Art Works youth group, an ARM had two major advantages over a fixed-rate mortgage: The lower interest rate on the ARM let her qualify for a bigger loan. And she doesn’t expect to own the home for very long — Miss Klein and her boyfriend moved to the Boston area for their careers, but don’t intend to settle there for the rest of their lives.

“We’ll probably head to the West Coast, and our time frame is about five years,” Miss Klein said. “For that reason, the five-year, adjustable-rate mortgage makes sense for us.”

Richard A. Gillespie, chief marketing officer at GMAC Residential, said the main argument for an ARM “is lower monthly payments and lower interest costs overall.”

He gave this example for a $150,000 loan: A 30-year, fixed-rate mortgage would carry a rate of 5.5 percent and require monthly payments of $851. The same-size ARM loan with a rate of 4.125 percent for the first five years would require $726 in monthly payments. After that, the rate could rise or fall a maximum of two percentage points a year, with a six percentage point cap.

A buyer who chose the ARM mortgage would save $10,230 in interest payments in the first five years, Mr. Gillespie said.

“The average person gets a new mortgage every five to seven years” because they refinance or move, Mr. Gillespie said. “If you take a 30-year, fixed-rate mortgage, you’re paying a premium for protection that isn’t necessary.”

That doesn’t mean that ARMs are for everyone.

Doug Duncan, chief economist for the Mortgage Bankers Association, pointed out that home buyers taking ARMs risk the possibility of higher interest rates in the future.

“That makes them better for people with higher wealth and income, or for people who are upwardly mobile and expect their income to rise steadily in the next couple of years,” he said.

On the other hand, a fixed-rate mortgage would be a better choice for families who don’t anticipate a lot of income growth or expect to stay in their homes for a while.

Keith T. Gumbinger, vice president of HSH Associates, a mortgage information publisher based in Pompton Plains, N.J., said borrowers considering ARMs should look carefully at how frequently interest rates are adjusted and evaluate the likelihood that rates will rise in coming years.

“A fixed-rate mortgage may be more expensive, but a lot of people are willing to pay for that peace of mind,” Mr. Gumbinger said.


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