Your Mortgage : ARMs Shine as Fixed Rates Rise : Interest: Widening gap between introductory rates on adjustables and fixed-rate mortgages make the former popular with new loan seekers.

Adjustable-rate mortgages are taking on new luster, now that fixed-rate loans have risen and introductory rates on ARMs have dropped.

About 40% of all home loans made today carry an adjustable rate, according to the United States League of Savings Institutions. Just last January, ARMs accounted for only 20% of lending activity.

The widening gap between introductory rates on ARMs and rates on fixed loans account for the renewed popularity of adjustables, many experts say.

Fixed-rate loans are typically most popular when they are no more than two percentage points higher than introductory rates on ARMs. Borrowers figure that it’s worth paying the slightly higher rate to lock in their mortgage payment for 30 years.

But when the gap between introductory rates on ARMs and fixed-rate mortgages exceeds two points, borrowers usually opt for adjustables because the lower ARM rate will save them a lot of money in the early years of the loan.

Since fixed-rate loans currently average about 10 1/4% and ARMs with a starting rate below 8% are fairly easy to find, a growing number of borrowers are answering the call to ARMs.

“ARMs are clearly more attractive than fixed-rate loans,” said Sam Lyons, senior vice president of Great Western Bank.

“When you look at the (initial) payment that you’d make on an adjustable-rate loan and compare it to the payment you’d make on a fixed-rate loan, there’s a huge difference.”

For example, initial principal and interest payments on a $150,000 ARM at 8% would be $1,100 a month. Payments on a $150,000 fixed-rate loan at 10 1/4% would be $1,344.

Of course, the biggest problem with choosing an ARM over a fixed loan is that the rate on the ARM will vary. That’s fine when rates are going down and your payment is dropping, but it’s bad news when rates move up and your payment follows suit.

“Adjustable-rate mortgages look pretty good right now, but you should take a fixed-rate loan if you can’t stomach the thought of the payments on an ARM going higher,” said Mike Wilson, an economist at the U.S. League.

It’s also important to note that although today’s fixed rates of about 10 1/4% are higher than they were a few months ago, they’re relatively low compared to the rates that were charged throughout most of the 1980s.

Still, a recent report by Wilson’s trade group indicates that borrowers who were willing to accept the risk of ARMs over the past decade have come out ahead of homeowners who opted for fixed-rate loans.

The trade group looked at two mythical borrowers, each of whom purchased a home with a $100,000 loan in 1981. One buyer chose an ARM that would follow mortgage-rate trends; the other opted for a fixed-rate loan of about 15 1/2%, which was the going rate at the time.

Today, the buyer who chose the fixed-rate loan would have paid $144,000 in interest charges. The ARM borrower would have paid $111,000--about 25% less.

Although the analysis indicates that ARM borrowers tend to do better in the long run, it’s not proof-positive that an adjustable-rate mortgage will always be your best bet.

For example, the mythical borrower who took out the fixed-rate loan probably would have refinanced when mortgage rates dropped into the single digits in 1986 or again in ’87.

He’d be enjoying a 9% fixed rate now, while the ARM borrower--who’s rate has long since been adjusted to market levels--would be paying about 11 1/4%.

Here are some tips if you’re looking for an ARM today:

Find out which index is used to make periodic rate adjustments. One common index is the 11th District Cost of Funds, which moves rather slowly. Another is the one-year Treasury Index, which tends to be volatile.

Ask what the margin, or “spread,” is on the loan. The margin is the lender’s retail markup: If the index rate is 9% and the margin is two points, your interest rate will be 11%. If the margin is more than 2 1/2 points, you might want to look for a loan somewhere else.

Ask how high your rate can go at any adjustment period. You’ll want to make sure the loan has a “cap” that keeps it from rising more than one or two percentage points each time the rate is changed. If you were paying a 9% rate and had a two-point cap, it couldn’t go higher than 11% the next time it’s adjusted.

Also ask about the lifetime cap. This dictates how high the rate can go in a “worst-case” scenario: If the loan starts with an 8% rate and has a five-point lifetime cap, it can never go over 13% even if rates skyrocket.