Should You Run From
Adjustable-Rate Mortgages?

Question: Please let me the most important things to look out for on an adjustable-rate mortgage. We are buying a home for $78,000. We are approved for a loan and will sell our present home within six months or less and pay down our 90% loan-to-value mortgage. We will have a $72,000 ARM and pay down $50,000 within a year or less to reduce the mortgage. This is the reason for the ARM.

We will have the loan amortized for 30 years but will pay it in 10 years. We paid our current home (it cost $42,000) in 42 months. This is our last home, since my husband is 68 years old.

Dear Maria: I advocate paying off your home as you grow older. Nearly 25% of older Americans have done this and it provides a real sense of security.

However, there are a few traps you must watch out for. One of the biggest is ending up land poor. You indicate that you will pay down $50,000 within the first year of the mortgage. That's fine, but what will you do if something happens, such as a medical emergency, and you need the cash?

My suggestion is that as soon as you pay down the existing mortgage, get a revolving line-of-credit (home equity loan), so you can draw out your money if and when you need it.

You emphasize that you are getting an adjustable-rate mortgage, however, there is no advantage here if you plan on keeping the loan for four to 10 years as you indicate. Paying a portion of an ARM off early does not normally lower your monthly payments or affect your interest rate.

There are two good reasons to get an ARM. The first occurs when interest rates are high and you need the lower initial rate of an ARM in order to lower the monthly payments to affordable levels.

The second reason is because ARMs offer a low "teaser" or initial interest rate. (Sometimes you can find ARMs with teasers that keep the loan low for a year or more.) If you plan to sell or pay off your loan quickly, in a year or so, you can take advantage of this teaser to get an exceptionally low rate.

In today's market, however, even fixed rate loans are still not that high. You mention you're getting a "30-year due in 10." These are available as a fixed-rate loan with lower interest rates. If you get one, be sure that yours has a safety valve -- if you cannot pay off the loan in time, it converts to a 30-year ARM.

One last caution: Beware of a prepayment penalty that some lenders have begun using. If you pay a significant portion of the loan off early, it could trigger the penalty. Look for a loan that does not have a prepayment clause in it.

Mr. Irwin has more than 25 years' experience as a Los Angeles-area real-estate broker. He is the author of more than two dozen books about real estate and is recognized as one of the most knowledgeable writers in the real-estate field. Mr. Irwin's most recent book is "Tips & Traps When Buying a Condo, Co-op or Townhouse," (McGraw-Hill, 1999).

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Maria, New York

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