P>The answer depends on how long you plan to live in your home and the rate differential between fixed and adjustable rate mortgages. While most homeowners opt for 30-year fixed mortgages, most mortgages aren't held nearly that long. According to Freddie Mac, the average life of a 30-year mortgage is five years, with the mortgage being refinanced or paid off due to a home sale (Source: Kiplinger's Personal Finance, May 2004). The ARM's lower interest rate may make it a good alternative if you plan to move in a short period of time or are willing to take the risk that rates will increase later for lower mortgage payments now.

You can obtain an ARM with an interest rate that is fixed for one year, five years, or 10 years, which adjusts periodically after that initial period. Compared to a 30-year fixed mortgage, a one-year ARM is typically 2% lower, a five-year ARM is 1% lower, and a 10-year ARM is slightly lower. Before obtaining an ARM, consider these factors:

• The initial interest rate. Make sure you understand how long the rate is effective, especially if it is a teaser rate.
  
  
• The index used for rate adjustments. The two most common indexes used are the One-Year Treasury Constant Maturity Series and the 11th District Cost-of-Funds Index. While both indexes have averaged approximately the same, the Cost-of-Funds Index tends to be less volatile, which could be good in an environment of rising interest rates.
  
  
• The period between adjustments. Find out how frequently the interest rate will be adjusted. Options include monthly, every six months, and annually. Less frequent adjustments mean your mortgage payment will not change for a longer period.
  
  
• Interest-rate caps. Determine how much the first adjustment can increase (typically capped at 1% to 5% over the initial rate), subsequent increases (typically 1% to 2%), and the maximum increase over the loan's life (typically no more than 5% to 6% over the initial rate). Then calculate how your mortgage payment would change in the worst-case scenario.