Question: No one can predict where rates will go, but one thing is for sure: you’ll be paying 6.25% when your rate adjusts in four months. That’s the nature of ARMs. After that, the market will determine your rate.’m currently eight months into a 30 year ARM on a house my wife and I bought last Fall. The current rate is 4.25% and can go up no more than 2% a year; there’s a lifetime increase cap of 6%, so the maximum rate this loan can hit is 10.25%.

We don’t know how long we’ll be in this house. We like the house and the area, but have some concerns about the school system. Our daughter is 2, so we have a few years to worry about it. The only reason I can see right now for moving within the next 5 years is if the public system turns out to be bad and the private schools aren’t a possibility for one reason or another. So we’re more likely to stay than move, but it’s not definite.

The only way I’d refinance now to get a fixed rate is if I can do it with *NO* cost to me. I won’t pay points, origination fees, processing fees, etc. I *can* get attorney services for free through work, so that’s not going to cost me anything. Luckily, I just got a flier from a mortgage broker I used several years ago offering 30 year 8% fixed loans with “no closing costs!” I did a similar deal with them back in ‘92 and it really didn’t cost me anything, so I know it’s not just a come-on.

Now, a question about ARMs: I know my rate is linked to an “index” and a “margin.” I also know that if these figures rise, my lender will raise my rate as much as he’s allowed. But what happens if my rate gets up to 10.25 and then overall interest rates (and thus the index) decrease? Will/can my rate float *downward* or am I stuck up at the top for the remainder of the loan period? (I’d guess I’m stuck; that’s the game: the lender gives me a nice rate in the beginning with the hopes that I’ll pay much more a few years later if rates rise.)

It seems easy to compare a 7.5 or 8% fixed rate loan against the “worst case scenario” of my ARM (4.25% now -> 6.25 next year -> 8.25 year after that -> then 26 years at 10.25). It’s a no-brainer: 30 years at 8% fixed beats 26 years at 10.25%.

But what if rates *don’t* go up in the next few years and I get to sit at 4.25 or even 6.25%? If I go with the fixed rate, and rates don’t rise, I’ll end up paying more than I had to.

I realize everything is a gamble; mortgage lenders do it every day and homebuyers have to do it, too. Looking at the past 10 years or so, an 8% fixed rate seems pretty good, and I’m inclined to just get it and not worry about indices, margins, and Mr. Greenspan. What do you think? If you have an opinion on this, please

Answer: No one can predict where rates will go, but one thing is for sure: you’ll be paying 6.25% when your rate adjusts in four months. That’s the nature of ARMs. After that, the market will determine your rate. Yes, “no-cost” refi loans exist; you will pay the costs, of course, but with a higher rate instead of out of pocket. No, your rate will rise _or_ fall based upon the movement of the index, and will be subject to the loan’s caps — which limit rate decreases as well as increases. It’s all spelled out in the loan documentation; I suggest you read it.

To see how this affects your payment, find a good (shareware) software program. But now you know that your rate can go _down_ as well as up, so it’s not so simple. FWIW, even under a worse-case scenario in which the ARM shoots up to the rate ceiling before falling, you’ll find that the _total_ outlay of P&I will be less over a five-year period than if you took a FRM which was 2% higher. That’s not to say the rising ARM payments won’t be a pain, though… Since no one can predict rates, you got it: you pays your money and you takes your chances. If you’d like to play “what-if” scenarios with various assumptions as to what rates will do, there’s a variety of mortgage-related shareware which will let you do that. We have a good collection on our BBS, or on any of the other real-estate BBSs on Ted Kraus’s list (posted regularly in m.i.r-e), or on America Online.

If you want my advice as to what to do, there’s only one answer I can give you: How well do you want to sleep at night? :-} Since you can’t know which decision will be better, rely on your comfort factor.

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