Adjustable-Rate Mortgage for First-Time Buyers

Reader Question: Is an adjustable rate mortgage a bad idea for first-time home buyers?

This is one of those questions we cannot answer one way or the other, because it really depends on the situation. In some cases, an adjustable-rate mortgage (ARM) loan can be used wisely to save the home buyer money. In other cases, the risk outweighs the rewards. So the best thing I can do is explain how adjustable-rate mortgages work, and what situations might justify using one.

Actually, most of the ARM loans these days are hybrid loans. That is, they have certain qualities of a fixed and adjustable mortgages, combined. For example, the loan starts with a fixed rate for an introductory period of time. This initial period may last anywhere from 3-7 years. After this initial fixed phase, the ARM loan will adjust -- meaning the interest rate will reset to a different rate. The caveat, of course, is that you don't really know whether the rate will go up or down at the adjustment. In most cases, the interest rate will increase, which means the size of the mortgage payment will also increase.

The Adjustable Mortgage Refinancing Crunch

This is why most home buyers who use adjustable-rate mortgages try to refinance the loan before the adjustment comes. Most ARMs will start off with a pretty low interest rate during the initial phase, which is something that's used to lure in borrowers. But after those first few years, the loan is going to start adjusting to a new interest rate on a periodic basis.

If you can use an adjustable-rate mortgage and refinance it later on before it resets, you are in good shape. But the problem a lot of people are having right now is that they cannot refinance or sell their homes (for a variety of reasons), so they're stuck with their adjustable mortgages and the uncertainty of the adjustment period.

How to Use ARM Loans Wisely

So let's get back to your original question. There are certain occasions when it does make sense to use an adjustable-rate mortgage instead of a fixed loan. One example would be when you're living in a house for only a few years, after which you will sell the home and move. In this kind of scenario, you can use an ARM loan to save money during the initial phase, and you can sell the home before you reach the adjustment phase. So this is a smart strategy that can save you money while avoiding risk at the same time.

I used this kind of financing strategy when I bought my first home, because I was in the military at the time. I knew I'd only be at a particular duty station for three years or so. We had a pretty good idea we would be moving after that, so we used an adjustable mortgage to secure a lower interest rate and save money over the three years that we lived in the home. We sold the home and moved long before the loan adjusted or "reset" for the first time.