The Ups and Downs of
Adjustable-Rate Mortgages

Question: We just bought a home and it's in escrow. We're trying to get the lowest interest rate mortgage and a lender suggested an adjustable-rate loan. The interest rate is only 5.6%. Is there any reason not to get this loan?

John: The rate you mention is the "start rate" or what used to be called the teaser. (A term most lenders prefer not using these days.) The start rate is used to entice borrowers to get the adjustable-rate mortgage). Typically it lasts only a few months to two years. Then the true interest rate rises to slightly higher than the market rate (to make up for the lower initial start rate).

I feel there are really only two justifiable reasons to get an ARM . The first is when interest rates are high and the only way you can get into a property is with an ARM. You get it because you must.

The other is when you only plan to hold the property a short time. You take advantage of the teaser to get a low initial start rate. Then, after a year or so when the interest rate has risen, you resell. In effect, you've turned the tables on the lender taking the cream of the mortgage and leaving them with the remains.

I'm not much swayed by arguments that say that an advantage of an ARM is that the rate you pay falls as interest rates in general go down. Usually the ARM lags other interest rates in falling. And in any event, when fixed rates fall, you can refinance, often with a no points/no cost loan.

Fixed-interest rate mortgages today are still fairly low. By agreeing to a balloon payment after seven or 10 years, you can often get that rate down another quarter to half a percent. (You can always refinance the balloon, if you haven't sold the property by then.)

Unless you're in the two categories I mentioned above, my suggestion is that you stick with a fixed-rate mortgage.

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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John, San Francisco

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