Many home buyers heed a call to ARMs

As rates for traditional mortgages rise, more buyers are opting for adjustable rate mortgages, or ARMs.

BY MICHAEL E. KANELL
Cox News Service

The more Americans start to catch a whiff of rising mortgage rates, the better adjustable rates look.

A growing number of consumers are moving away from the traditional, 30-year fixed mortgage and instead are snagging an ARM -- the adjustable-rate mortgage -- to either purchase a home or refinance the one they own.

The reasons vary, as do the risks.

When rates start to rise, some people leap from an adjustable to a fixed rate. They want the security of knowing that, no matter what, they are ''locked in'' to one payment for the life of the loan.

TAKING A GAMBLE

Yet some homeowners choose ARMs, gambling on higher rates down the road so they can afford a pricier home now. Some like the flexibility -- they decide whether to pad the house payment each month -- while still others figure they'll move before the rate does.

Though rates in recent weeks have dipped, most economists expect them to rise again in coming months. Among the reasons: The Federal Reserve has been lifting short-term rates, inflation has been rising and the economy has been growing.

Worriers warn the trend toward ARMs makes consumers and the broader economy more vulnerable.

Advocates scoff -- what could be wrong with an option that lowers monthly payments and gives borrowers more flexibility?

Choice and lower cost are an unbeatable combo, said Nick Schittone, 32.

He and his wife have a seven-year ARM on their Atlanta home. They pay about $500 a month less than before they refinanced.

''It's all about flexibility and options,'' he said.

About one of every three mortgages is an ARM, an increase from less than one in eight just four years ago, according to the Mortgage Bankers Association.

A traditional fixed rate ''locks in'' one interest rate and one monthly payment amount. An ARM's rate holds steady only for a set period, maybe years or just months. The shorter the initial period, the lower the starting rate.

HIGHER PAYMENTS

After the ARM's initial period ends, the rate adjusts, its new level linked to some financial instrument, such as the five-year Treasury note. So if rates have risen at that point, a borrower would face higher monthly payments.

For some, an ARM is a way to get more house for the same monthly payment. For others, it is the only way they can afford to own a home at all.

A person borrowing $200,000 at the fixed rate of 5.5 percent, for example, would pay $1,135 each month in principal and interest, said Brooks Campbell, senior vice president of Vanguard Mortgage.

By comparison, if you have just $800 you can devote to a monthly payment and you took the fixed rate, you could qualify for only a $140,000 home, Campbell said.

But here's the catch: That adjustable could jump as much as 5 percentage points in 2010, he said. 'If you say that in five years maybe you will still be in the house, I say, `Let's look at a 30-year fixed.' ``

ARMs can also allow borrowers to have more cash on hand. That lure is even stronger in interest-only ARMs, which let borrowers keep their required payment at its barest minimum. They add nothing each month to the equity they have in their home -- unless they choose to.

Take that $200,000 loan, for example: An interest-only adjustable at 4.625 percent would mean a monthly payment of just $770.83.

Jason Green, 36, and his wife bought a house in Cumming with a fixed-rate mortgage set at 7.5 percent in 1999. But rates kept dropping, so they refinanced. Twice. Now, they have a five-year ARM at 4.75 percent. ''I am betting that over five years, it won't go to 7.5 or 8 percent,'' Green said. ``It's a gamble.''

An interest-only ARM puts a premium on borrowers' savvy: If homeowners can budget money to frequently pay down part of the principal, they not only cut their long-term obligations, they amass equity in their homes.

THE EQUITY ISSUE

If they cannot afford to -- or if they pay just the minimum -- they gain no equity. An owner who pays only interest is betting the home will grow in value. If it doesn't, he or she could walk away with nothing, or even owing money.

ARM and interest-only mortgages are signs that borrowers are getting better about fitting their mortgages to their financial situation, said Bob Walters, chief economist of Quicken Loans.

After all, he argued, fixed rates have risks, too: Most of what a borrower pays in the first few years is interest, and being locked in to one rate is pointless if the borrower doesn't keep the mortgage.

``In this world, borrowing long and paying the premiums doesn't always make sense.''

What worries economists most is the idea of millions of homeowners simultaneously slamming into a financial wall, unable to make monthly payments or unable to sell their homes. For homeowners, loss of income is the greatest danger. A rate that goes up only adds to the potential for problems.