Q I hear about using ARMs for mortgages, but what are the risks? What happens if the property depreciates and interest rates go up?
James, Minneapolis
Adjustable-rate mortgages (ARMs) can be a great tool since you can get a rate lower than a fixed-rate mortgage. The downside is the interest rate can fluctuate, just as the name suggests.
Typically, you can get a one-year, 5/1 or 7/1 ARM, meaning the rate would be fixed for the first one, five or seven years. After that the rate, and therefore your payment, can be adjusted up or down every year depending on where interest rates are heading.
Many young people probably won't own their first home or condo longer than five to seven years, so an ARM is a great option. But if you anticipate owning the property for a longer time, a fixed-rate mortgage might be better so that you can lock in your payment and allow for better budgeting.
The housing market has slowed from a few years ago; however, properties have not started to depreciate. If that were to happen, the concern would come if you wanted to sell. First, you could receive less than the amount you originally paid. Second, you want to make sure the value of your home is still higher than your mortgage amount, otherwise the mortgage company could technically require that your loan be paid in full because you do not have the same amount of collateral that was initially pledged. (This is the case no matter what type of mortgage you use.)
Kristin Hannemann, CFP (30)
Clarification
