An adjustable rate mortgage or ARM is one where an individual has a set interest rate but only for a set number of years.
For example, a "7/1 ARM" has one rate, usually lower than the current fixed rate, for seven years. After that, the interest rate will adjust annually to reflect the current market.
In the past, this type of loan has gotten homeowners into hot water as rates adjusted up, taking monthly mortgage payments with them. But with rates at historic lows, homeowners with ARMs may be in for a surprise.
“I think when a lot of people took these ARMs they were anticipating the interest rates could possibly go up and they were taking a gamble. But surprise, they've not only not gone up, they've gone down, so you find yourself paying less when your interest rate adjusts,” says Cybele Weisser, senior editor of Money magazine.
Significantly less. In fact, a few points difference could shave hundreds of dollars off your monthly mortgage payment. And assuming you have a 5/1 or 7/1 or 10/1 ARM, that new lower rate will remain in place for 12 months. But what happens after that?
“We do know that after 2013 rates may go up because they have no place else to go but up,” says Carmen Wong Ulrich, president of ALTA Wealth Management.
That is why Ulrich says if a person plans to stay in their current home for the long haul they should refinance now, even if the fixed rate is higher than the current adjusted one.
“It actually makes more sense to first incur the cost of maybe higher monthly rates but also closing costs. You have legal fees and taxes but if you’re staying put over the long term, this could save you thousands in payments for 30 years fixed-rate mortgage,” Ulrich says.
However, if a person is planning to move in the next few years, their best bet may be to do nothing. Even if rates do start climbing, Weisser says the increase will likely be gradual. Plus there are caps on how much a rate can jump at any given time.
“If you are very, very certain that you are going to leave in a year or two, it's possible that your interest rate could just get back to where you were at worst. There's a pretty good chance of that, that you could comfortably ride it out,” Weisser says.
But she agrees if there's even a possibility of staying, it probably makes sense to lock in a lower rate now.