'Always go with a fixed rate mortgage (FRM)'
The other day, Roxanne approached me saying that she was going to refinance to a 20 year FRM. When she told me that she only planned on staying in the house for about 5 more years, I was shocked. 'Have you considered refinancing to an adjustable rate mortgage?,' I asked.
She told me that her husband thinks ARMs are too risky and that he heard that he should always go with a fixed rate mortgage. I explained that the decision to choose between an ARM or FRM really depends upon the circumstances and that sometimes an ARM really can be the right type of loan to refinance to.
For her situation, I recommended checking the rates of a 5/1 ARM, meaning that the mortgage would remain fixed for 5 years and then adjust annually for the remainder of the term. My reasoning behind it is that the beginning fixed rate of a 5/1 adjustable rate mortgage will be lower than the rate you would get for a fixed rate mortgage. By the time the loan rates start adjusting, she would be ready to sell.
There is always that chance that she won't be able to sell or will change her mind about selling and will have to stay with that ARM. When making this decision one should perform the Scenario Analysis, discussed by mortgage professor, Jack Guttentag, in 'Choosing Between Fixed & Adjustable Rate Mortgages', to be aware of the best and worst case of a particular ARM."
