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Lower interest rates are the chief advantage ARMs offer borrowers. If rates hold steady or fall, ARMs save borrowers money. But if they rise....

Given the uncertainty built into them, one might wonder why anyone would opt for an adjustable-rate mortgage over a fixed-rate one. But there are reasons why home buyers prefer them, some good, some not so good. Both stem from the chief advantage adjustable-rate mortgages offer:

Lower monthly payments, at least at the outset.

Because adjustable-rate mortgages charge interest based on short-term rather than long-term interest rates (we will have more to say on this subject in a future installment), the interest rates on ARMs are lower than those for fixed-rate mortgages. This makes them especially attractive when interest rates are high, and when they are high, there is also the prospect that they are more likely to hold steady or fall than to continue rising. When rates are steady, ARM borrowers remain ahead of fixed-rate borrowers because the ARM’s rate is based on lower short-term rates rather than higher long-term ones; when they fall, ARM borrowers save even more. Holders of fixed-rate mortgages would have to refinance in order to take advantage of lower rates, and refinancing may not always be an option.

But what if interest rates aren’t high?

That’s where the problems begin. If interest rates rise, so will your monthly payments when the mortgage’s rate adjusts. The seriousness of this problem depends on two things: how far interest rates rise and how often your rate adjusts. If it adjusts only once, and the increase in interest rates is not that large, it may not be much of a problem at all. But if either of those conditions does not apply, your payments could rise to the point where you may not be able to afford them, and even if they don’t, you could end up paying more for your mortgage overall than you would with a fixed-rate loan.

In our next installments, we will go into the reasons, both good and bad, why borrowers consider ARMs, and the questions you should ask yourself before making the decision to obtain one.