Reasons to Choose an ARM When Refinancing

I previously wrote on the reasons to choose an FRM when refinancing. However, there are various reasons to choose an adjustable rate mortgage (ARM). Generally, an ARM works so that interest rates are fixed for a set amount of time and then adjust periodically afterward. The rates can increase or decrease depending on the market.

I discussed Roxanne's situation in "Refinance Rumors", because she was considering only an FRM without looking into a 5/1 ARM. Since she was planning on moving out of her home in 5 years, she could have taken advantage of the lower initial rates offered by the 5/1 ARM and then sold after the 5 years were up. This would allow her to save a lot more than she would have with the FRM. Naturally, there is some risk involved if there is difficulty selling your home when those 5 years are up.

I like to advise people like Roxanne to take into account this possibility of being unable to sell. So why should anyone unsure of when they will be selling their home choose an ARM?

If you are just starting out your career or recently lost your job, you might be short on income and unprepared to pay the higher cost on an FRM. If you are fairly certain that you will be receiving raises on your income in the future, then an ARM might be an ideal choice for you this way if rates increase when your rate adjustments kick in you will be able to pay for it.

Another reason to choose an ARM is if you need to free up cash for some current expenses. This is another example of time that the lower temporary fixed income rate could come in handy.

I can't emphasize enough the idea of performing the scenario analysis discussed by mortgage professor, Jack Guttentag in "Choosing Between Fixed and Adjustable Rate Mortgages". Figure out your payments if you were to choose an FRM, and then test a few possible scenarios with the ARM. This will allow you to see the potential rewards and consequences you might encounter with the ARM. Before you are set on choosing an ARM, be aware of the worst case and whether or not you would be able to make the payments. If you are comfortable with the risk, go for it.