Given the uncertainty surrounding interest rates, consumers might want to think long and hard about taking out adjustable-rate mortgages, even if they seem cheap in comparison to fixed-rate loans, according to some advisors.
Adjustable-rate mortgages typically have a fixed rate of interest for a certain period of time — often five or seven years — but after that period, the rate on these loans fluctuates, at preset intervals, in tandem with a predetermined index.
In markets where home prices have soared recently, home buyers might be tempted by the lower initial rates of ARMs, figuring they can convert to fixed-rate mortgages before higher rates kick in. But that assumption has gotten many borrowers into trouble in the not-so-distant past, said certified financial planner Kent Grealish of Grealish Investment Counseling.
"If you don't have the ability to handle whatever that reset rate, you might get into trouble, particularly if we have a soft real estate market and you can't refinance your loan," he said. "You need to consider how you will be impacted if your mortgage rate rises, especially if that coincides with some sort of big financial event, such as a job loss or reduced hours at work."
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Some advisors say 7/1 ARMs may make sense for those who are close to retirement and plan to sell their homes relatively soon. Thanks to the low initial rates on these loans, homeowners nearing retirement can minimize their housing-related costs, freeing up cash for other purposes in anticipation of selling their homes, said certified financial planner Stephan Quinn Cassaday, president and chief executive officer of Cassaday & Co.
Cassaday said many of his clients who have mortgages are wealthy enough to pay them off early. However, they are generally better off investing the money they would use to do that, he added, given the expected spread between their investment earnings and after-tax loan costs.