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I'm on the cusp of signing a 30-year fixed mortgage at 3.8% interest (I might even be able to negotiate it down to 3.6%).

Looking at historical interest rates, it's a dead-certainty that interest rates will rise over the next 30 years, in all liklihood way above 6-7% through the life of the mortgage, possibly even higher (thinking of the 16% in the early-1980s). There's also speculation it will rise.

A lawyer friend of mine suggested I get an ARM instead (and qualify for a 3.1% interest rate for 7 years) and said that if interest rates increase to something seriously unprofitable for the bank (above 8%) the bank might invoke some force majeure clause or other trick to nullify the contract and raise the interest rate.

Is there any truth behind my friend's remarks? Obviously I'll ensure that the contract is watertight in my favour, but his piece leaves me a bit rattled.

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Better get a paid legal consultation instead of talking to lawyer friends. Once an attorney has to write his opinion down, substantiate it and stand behind it in court - he'll be much more cautious about advice he'd be giving you. NO attorney in their right mind will sign off on telling you that taking an ARM is better in the long run than taking a fixed rate loan.

ARM means that after the initial period (7 years, in your case) the bank will raise the rates, to the levels the rates will be then. In 7 years, as you said, the rates are bound to go up. After that, the adjustment will be annual, so every year the bank will raise the rates. Because why not? you're stuck with the loan already.

With fixed rate loan your rate is, well, fixed. The bank will not raise it. It will not be unprofitable to the bank. Ever. Because the bank got the money for 0%, and is giving it to you for 3.6%, so the bank is making a profit on this loan. The cost of money to the bank for this loan is not going to change, since the bank gives it to you now, and it costs the bank the current price. Which is, as I said, 0% - the current Fed rate.

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