4. Save your bet
Experts almost agree that after so many years of very low rates, interest rates can only go in one direction in the near future: up. When you choose to use an ARM, do some “what-if” projections.
“Calculate where to start the loan, what the worst-case scenario you might face, and a practical intermediate scenario,” says Gumbinger.
After calculating the numbers, decide whether you can manage the loan at different levels. At the very least, you should be able to change the median financial forecast for your ARM. If not, reconsider the credit.
Another tip: use your mortgage savings to build up a cushion of liquidity.
If refinancing into an ARM lowers your mortgage payment by, say, $ 400 or $ 500 per month, save those funds in a separate account that you don’t touch. That way, you’ll at least build a financial safety net to balance and prepare for time in the future if and when there are higher monthly payments. “Even if we go back to the more normal rates – around 7 to 8 percent – that would be very uncomfortable for some borrowers who have become used to 3 or 4 percent rates,” says Gumbinger. The extra cash cushion you amassing could make up some of that financial blow.
Both strategies allow you to hedge your bet a bit when using an ARM. But ultimately, when you buy an ARM, you have to come to terms with the fact that there is some uncertainty about interest rates.
“Are you going to do it better or worse in the future? It’s a bit of a gamble,” says Gumbinger. “You really don’t know if it’s going to work or how it’s going to work.”
That is why it is important to look around first, to find out about loan products and to know your time horizon, recommends Cecala. “Don’t just think about what you can afford” but also “which loan will protect you best”.
Lynnette Khalfani-Cox, The Money Coach (R), is a personal finance professional, television and radio personality and is a regular contributor to AARP. You can follow her Twitter and further Facebook.
