When it concerns buying a house, you need to make many decisions. You have to determine which community you want to live in, which school district, how much of a down payment to make, etc. One of these choices is what type of loan program you want, whether you will take out a fixed-rate or adjustable-rate mortgage.
A fixed-rate mortgage is one of the most common kind of mortgages. The interest rate and monthly payment (principal and interest, excluding tax and insurance) using this kind of mortgage remains the same all over the life of the loan.
Adjustable-rate mortgages will begin with lower interest rate than comparable fixed-rate mortgages, but the interest rate of an ARM has the ability to change. When it does, the payment will increase if market rates are increasing, and down if rates are dropping. There are caps that limit how much your payment can change, but some people experience “payment shock” when mortgage payments increase. If you select an ARM, ensure you recognize how high your payments could possibly go.
Hybrid mortgages, as the name suggests, provide you a mix of both kinds of mortgage. Specifically, you’ll begin with a fixed rate for a set time (frequently five, seven or 10 years). For that initial period, you will know for certain what your principal and interest payments will be. When the lock period is up, your mortgage rate can adjust, typically changing yearly. If a mortgage is called a “5/1 ARM,” that means it has a fixed rate for five years, and can change once a year after that.
Which mortgage to choose
Just like so many personal-finance questions, the type of mortgage that’s right for you depends very much on your situation. The standard pointers is if you intend on living in your home for only a few years, you might want to consider an ARM or hybrid. You would save money because the interest rate for the ARM would be lower during those initial years compared to the fixed rate mortgage.
Interest rate yield curve – There are times when there is a large spread between the fixed mortgage interest rate, and the ARM… and times where they are relatively the same. If the interest rates between the programs are the same, definitely take the fixed rate. If there is a large spread between the rates, you have to analyze the amount saved in taking the ARM, and let it “bribe you”. Presently there is a large 1.5% deviation between the 5/1 ARM and the 30 year fixed. That’s a lot of money towards interest over the 5 year period being paid towards insuring what the interest rate will be in year 6. If you are relitively sure you won’t be selling the property, or refinancing the property for many years, paying the higher fixed rate may be worth it.
Certainly, as the latest recession and housing crisis showed us, you can’t necessarily sell a house easily if the economy is weak. So if you choose an ARM, you need to be prepared to pay the higher allowable interest rate when it adjusts. Fixed-rate mortgages offer the security of knowing your principal and interest payments will be the same for the life of the loan. If rates increase, you don’t need to stress over it; if they reduce, you can consider refinancing. You can also refinance from an ARM to a fixed-rate mortgage to lock in a lower interest rate for the longer term.
Should you refinance?
So let’s say you are in that very position– with an adjustable-rate mortgage, thinking about refinancing to lock in a lower interest rate. Interest rates aren’t as low as they were a short time ago, but they are currently in traditionally low territory. There are some points to think about– the rate (and limits) of your present loan, the value of your home, your equity in the home and the current interest rate. There are considerable costs when it concerns refinancing, so if you plan to sell your house soon, it might not be the most effective decision. If you can still acquire a lower interest rate, while incorporating the closing costs into the rate (called a 0 point, 0 cost loan), it almost always makes sense to refinance. All you’re doing is pushing paper. Eventually, you have to look at your individual situation and financial goals to identify if refinancing to switch from an ARM to a fixed-rate mortgage works for you.
If you are in the LA region, and have any specific questions, always feel free in contacting me through my website, or my email address or phone number shown below.