Fixed Rate Mortgage or Adjustable; What"s Right for You?

There are many different types of mortgage loans. The two most common types of mortgage loans for real estate are the Fixed Rate Mortgage and the Adjustable Rate Mortgage, also known as an ARM. Knowing the features of these types of loans and how they differ from each other will help you decide which type of loan is best for you.

First let’s define them. A fixed rate mortgage is a loan where your interest rate is fixed for the life of the loan. You make the exact same payment every month. At the end of the loan term, the loan is paid off in full.

With an ARM, the interest rate is often fixed for an initial period such as 5 years. Then at the end of the fixed period, the interest rate will adjust at the end of a pre-set period like once a year. During the adjustment period Interest rates on ARM’s are derived by a fixed margin, often 2.25%, plus the value of the index that the loan is tied to such as the 1 year LIBOR, which at the time of this post was at .557%. In this example, when the loan reaches the adjustable period of 5 years, the rate will adjust once time a year to the value of the LIBOR plus the 2.25% margin. Then at the end of each year, the rate is recalculated to adjust with the value of the LIBOR. If you had an adjustable rate mortgage that was adjusting today based on the 1 year LIBOR and a margin of 2.25%, your rate would be 2.875% rounded up to the nearest .125 point increment. Not a bad rate right? Especially considering that they fixed rates are in the high 3’s low 4’s currently.

You might be asking yourself, if the rates are so much lower on an ARM vs. a fixed rate mortgage, why would anybody do a fixed rate mortgage at all? There are quite a few reasons why somebody would take one type of loan over another but let’s focus on the most common reasons. With a fixed rate mortgage, you always know what your payments will be. During times where interest rates go higher than your fixed rate, you’re still enjoying that fixed rate and payment with no fear of things changing on you. You can also typically borrow up to a higher loan to value ratio with a fixed mortgage. So if you have limited funds for down payment or limited equity, the fixed rate mortgage may be the only option.

Fixed rate mortgages are by far more popular than ARM’s because most people tend to be very adverse to the risk of their interest rate going up and therefore their payment but there are some pretty cool reasons to take the adjustable rate mortgage aside form just an initial period where the rate is lower. As I stated above, an adjustable rate mortgage adjusting today would be a rate of only 2.875 where fixed rate mortgages are at least 1% higher today.

Take a look at this comparison on the right. This is an example of somebody that took a loan out in 2012 and is now wanting to take advantage of today’s awesome rates. They could take this rate of 4.125% on a 30 year fixed rate mortgage and lower their payments by $199 per month. In this example I’ve applied that monthly savings toward their principal balance each month. In doing so, they’ll have this new loan paid off in just 22.5 years. Their current loan paying that same amount will take almost 28 years as show by the line labeled Freedom Point (the point at which you are mortgage free). Looks really good right?  But look at the 5/1 ARM. In that example the rate is almost a full point lower, and the monthly savings is $314 per month. You don’t have to apply that savings to the mortgage of course. You could use that money to pay off a car loan or other higher interest debt. You could put that toward your retirement. Maybe just brighten somebody’s day with flowers now and again?

The amount of interest you save over the life of the loan can be very significant with a fixed or an ARM loan but the ARM tends to offer more savings than that of the fixed. Generally speaking, those that take out an ARM loan as opposed to those taking out a Fixed Rate Mortgage, tend to pay less interest over the life of the loan. This is especially true during the introductory period. Take a look at the graph on the left. It demonstrates the same example as above but taking a look specifically at the interest savings over the 5 year fixed period. Notice that the 5/1 ARM saves an additional $10,000 over the 30 Year Fixed. The total savings over a 5 year period  on the Fixed is about $14,000 whie the ARM would save $24,000.

Regardless of which type of loan might be right for you, an ARM or A Fixed Rate, either option makes great sense when deciding whether or not to refinance. Saving between $14K and $24K in interest over just 5 years time is a make sense decision. If you you want to know if a refinance would benefit you and how you might be able to make the best of it don’t hesitate to give me a call for your Free Mortgage Review. Call Chris Reese at 916-502-1656 for your free mortgage review. You can also apply online at http://www.sacramentohomeloanspecialist.com/applyNow.html. Have a wonderful day and Make it Happen!

 

Fixed Rate Mortgage or Adjustable; What"s Right for You?