Adjustable Rate Mortgages: Time to Reconsider?

Mark Shapiro, owner of a public relations company in San Diego, went shopping last month for a mortgage to buy a house near Poway, Calif. Shapiro, pictured left, had every intention of following his mortgage broker's advice and choosing a 30-year fixed-rate mortgage. But then he looked at the difference between what he'd pay in interest for that fixed loan -- more than 5 percent -- versus 3.8 for an 7-1 adjustable rate mortgage.

To boot, the 30-year fixed was going to require more paperwork, since Shapiro is self-employed. The adjustable rate mortgage was easier to obtain.

Shapiro also likes the idea of being able to reduce his mortgage principal. "I love being able to throw in extra money whenever I feel like it and watch my payments go down," he told AOL Real Estate. "If it is a good month, I can throw in an extra thousand or so. If it is a tight month, I just pay the regular monthly bill.''

Shapiro's experience helps explain why adjustable loans are beginning to make a comeback.

Adjustable rate mortgages have earned a reputation as a main culprit -- along with
shady lenders and unbridled greed -- in the spread of foreclosures and waves of underwater homeowners. So why are consumers continuing to sign up for mortgages with interest rates that start out fixed but then float up or down, depending on the whims of international credit indexes?

Bottom line: They're cheap. And now that mortgage rates are beginning to drift upward, they look like an even better deal.

In the summer of 2004, way before the bubble burst, ARMs hit a peak, accounting for 40
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percent of all new home loans. Of course, a lot of that debt was of subprime quality, and by early 2009, adjustable loans fell to just 3 percent of the market, according to Freddie Mac's annual ARM survey. Since then, they've clawed their way back to about 7 percent of new mortgages. Look for that number to hit 9 percent by year's end, said Freddie Mac chief economist Frank Nothaft.

The number one considerations for borrowers deciding between a fixed or adjustable loan are how long they plan to live in the house, and how much risk they're willing to take on. That second part of the equation is a powerful argument for the fixed, long term loan. "It's been a crazy last few years and people don't really want to put themselves into a product that's going to adjust,'' said Matt Hackett, underwriting manager at New York direct lender Equity Now.

But for Mark Shapiro, the risk is worth it. In seven years, when his loan is due to adjust, he'll be looking to sell. And by then, he figures the market will have improved to the point where he'll break even. Or maybe -- he dares to dream -- make a tidy profit?

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