Any risks in this adjustable-rate mortgage play?

Posted by  on Sep 14, 2012

Q: I know an adjustable-rate mortgage may seem like a bad idea when today's mortgage rates are already at record lows, but then again, if no one thought rates could go this low, why can't they go lower? My plan is to get an adjustable-rate mortgage now and, if rates start to rise, refinance into a fixed-rate mortgage. Do you see any flaws?

A: Yes, there are potential flaws. First, though, to acknowledge what makes sense about your plan, adjustable-rate mortgages currently offer nearly a full percent advantage over 30-year fixed mortgage rates, and the adjustable feature gives you the possibility of getting an even lower rate in the future.

The rub, of course, is that you'd be exposed to rising mortgage payments if rates started to rise. Here are three things that could stand in the way of your plan to quickly bail out of your adjustable-rate mortgage if that started to happen:

  1. Your mortgage loan may be under water at the crucial time. When the housing market collapsed, many homeowners found themselves stuck in mortgages they wanted to get out of because they were unable to refinance once their homes were worth less than what they owed.

  2. Refinancing is not a cost-free activity. Closing costs on a new loan would eat away at any initial rate advantage you gained if you end up having to refinance. Also, you'd want to check the terms of your adjustable-rate mortgage very carefully before signing up, to see if there are penalties for early repayment.

  3. Timing can be tricky. Interest rate moves can be large and unpredictable, and people don't always have the time and discipline to follow through on financial strategies precisely. Your plan depends on not being caught out by bad timing for either of these reasons.

All in all, the odds are more in your favor if you lock in current mortgage rates, and plan to refinance only in the unlikely event that rates go significantly lower.

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