Does an adjustable-rate mortgage make more sense for a short ownership period?

Posted by  on Oct 26, 2013

Q: I'm buying a starter house that I only expect to own for five to ten years. I've heard that an adjustable rate mortgage can be a good move if you only plan to be in a house temporarily -- they start out with lower rates, and you won't have the mortgage long enough to be hurt too badly by rising rates. Is there a rule of thumb as to how long you plan to own your house and whether an adjustable-rate mortgage makes sense?

A: There is no rule of thumb, but a mortgage calculator can help you work through some of the possibilities.

The reason there's no universal rule of thumb is that the trade-off between an adjustable-rate mortgage and fixed-rate mortgage depends on the specifics of the loans. There are four things you need to account for:

  1. The rate-adjustment period
  2. The periodic-adjustment cap
  3. The lifetime-adjustment cap
  4. The starting differential between fixed and adjustable mortgage rates

Where a mortgage calculator comes in is helping you calculate two sets of scenarios. First, produce an amortization schedule for a possible fixed-rate mortgage. Then, calculate a worst-case scenario based on the highest possible rate increases for the adjustable-rate mortgage you are considering. Compare the amortization schedules in each case, and you should see a crossover point in terms of the total amount scheduled to be paid -- with its lower initial interest rate, the adjustable-rate mortgage should be less costly, but will become more so as rates rise. The closer that worst-case crossover point is to your planned departure from the house, the less risky the adjustable-rate mortgage is.

One variable a loan calculator cannot measure, and which you will have to judge for yourself, is how sure you are that you will be moving within five to ten years. Any possibility that you would wind up being in the home longer would considerably increase the risk of an adjustable-rate mortgage.

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