Should you get a fixed rate or an ARM?

Right now I predict that rates will move upwards, unless there are significant factors barring this action. Those factors include: terrorist attacks on U.S. soil, another disaster like Katrina, or a sharp increase on oil prices like we suffered at the end of summer 2005. Rates remain low so I suggest people move to less volatile mortgage products, like: 30 Year Fixed, 30 Year Fixed Interest Only, and 40 Year Fixed.

The ARM, of course, is an adjustable-rate mortgage whose interest rate can go up or down. By contrast, a fixed-rate loan locks-in your rate for the life of your loan -- there's no need to guess as to where the rate will be next year or in 30 or 40 years.

At first glance, an ARM looks like a great deal next to a fixed rate. In most cases it is, but not when ARM rates are nearly as high as fixed rates. If you are not comfortable playing the odds, then play it safe. The average ARM rate nationwide is usually less than the average fixed-rate. Today they are not that much lower.

What should you watch out for?

If you do not play the odds right in your ARM mortage you can get burned as a result. With an ARM, your payments are lower for the first three or five years, and will stay low -- provided interest rates in general don't skyrocket. If they do, the lender typically will adjust your ARM rate upward by a maximum of 2 percentage points a year, and a max of 6 percent over the entire loan period.

An ARM that starts out at, say, 5.75 percent can increase to 7.75 percent in the second year, to 9.75 percent in the third year, and to 11.75 percent in the fourth year. Over that period your monthly payment would shoot up from $581 to $1,000. On the other hand, when most interest rates are in a decline, such as during a recession, that tends to keep ARM rates low.

How rates are computed?

Few homebuyers understand how ARM rates are computed: For the first year only, the lender uses a teaser rate to get you in the door. In the second year, he starts tying the rate to a publicly known index such as Treasury bills or the 11th District Cost of Funds. To that he adds his "margin," usually 2.75 percent, to arrive at your ARM rate for the new adjustment period.

But that rate is capped at the 2-percent-maximum-per-year described above.

Who should get an ARM?

When should you get an ARM -- or not get one? It depends on three things:
1. How long you plan to remain in your home
2. The unpredictable direction of interest rates.
3. If you plan to use the PayOption Arm with advice from a financial advisor

A homeowner that probably won't move again for five or more years should NOT consider an ARM at this point because fixed rates are relatively low. Better they lock up a 30-year fixed-rate mortgage at 6.25 percent to 6.5 percent or thereabouts.

By contrast, homebuyers who believe they'll be in their house for only five years or less will probably save money by opting for a PayOption ARM, since Libors and Treasury ARMs are just as high as the fixed rate. Though the ARM rate will rise over that short time frame, the bottom line, in dollars and cents, is that the buyer's total cost will be less than that with a fixed rate.