A very common question I get is; should a borrower go with a fixed or adjustable rate mortgage. It would seem that the answer is very easy since fixed rates are so incredibly attractive right now, but it really comes down to the borrower's short-term and long-term plans.
Fixed rates offer stability, and the ability to always know what your payment is going to be. It will never change. An adjustable mortgage is just what it sounds like "adjustable" or will change at a regularly scheduled dates.
The fixed rate will almost always come at a rate higher than an adjustable. Adjustable loan come with terms like, margin, index, life cap, adjustment caps, etc. These are the terms by which you loan can adjust. Generally speaking adjustable loans can go up or down. Although many adjustable loans set the floor rate or the lowest rate a loan can go.
So here is where we get into the meat and potatoes. The question of what option to go with isn't always simple. My first question to a borrower is typically, "how long are you staying in the home?" Or, "how long do you intend to own the second home or investment property?" And why does this matter? If an investor buys a home and plans on selling it quickly, an adjustable rate mortgage may be the best choice. If the owner plans on holding the property or will live in the property for five or more years then a fixed rate may be more advantageous.
Let's look at some real examples. Suppose you need a mortgage for $300,000 refinance purchase doesn't really matter. If you choose a 4.50% fixed rate you would pay $52,228.57 in interest payments over the first (4) four years.
Now if that same loan was an adjustable rate, say a 5/1 ARM at a rate of 3.50% you would pay $40,374.92 in interest payments over the first (4) four years. That's about $12,000 in savings over the fixed rate. So if you are planning on selling this property in less than four years, the adjustable is the correct option.
The closing costs on these loans are about even. So that was an easy one.
But what if the borrower planned on staying in the home forever and still wanted that adjustable rate? Here is what would happen if he chose an adjustable rate and stayed in the house for (10) ten years and the loan adjusted at the 5 year mark, and rates have gone up as many think they have to eventually. The interest paid over (10) years assuming rates rise will total $172,076. But that same loan as a 4.5% fixed rate over the same period would only require $122,674 in interest payments or $50,000 less than the adjustable rate mortgage.
In this case the long term fixed is clearly the best option.
The only drawback to a fixed rate is they cannot take advantage of rate declines. The adjustable rate mortgage talked about above could also adjust lower. In that event the fixed rate would require more interest payments over the same ten year period. But, in today's rate environment, where the cost of money for banks is almost zero, do you really think rates will stay here forever?
Ultimately, this is your decision as a borrower. Good luck out there!
About this Author
With over twenty years experience in mortgage lending, a Certified Mortgage Banker Designate (CMB) from the Mortgage Bankers Association of America, and billions in funded loan experience, I can assist you and/or your clients with the most important financial decisions related to your residential and commercial real estate. Please call or email me today
Michael A. Foote, CMB
Certified Mortgage Banker
949.584.4600
michael@michaelfoote.com
http://www.michaelfoote.com
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