September 24th, 2018 9:09 AM by Jackie A. Graves, President
You've been dreaming of owning a home for years, and now you're
finally ready to make the leap. You've found the perfect place and may have
even started deciding where to put the furniture, but you still have one big
obstacle standing in your way: getting a mortgage.
you've never bought a home before, the whole process can seem a little
confusing. One of the first things you have to figure out is whether you should
get a fixed-rate or adjustable-rate mortgage. Most people choose the fixed-rate
mortgage without even thinking about it, but there are situations where an
adjustable-rate mortgage may be a better fit.
How fixed-rate mortgages work
mortgage charges interest in order to make the deal worth it for lenders. With
fixed-rate mortgages, you lock in a single interest rate for the lifetime of
your loan. Usually, the payment period is 30 years, but it can be 20 or 15 if
you want to pay off your home more quickly.
reason fixed-rate mortgages are so popular is that they're more predictable.
You know exactly how much money to set aside out of your paycheck each month to
cover the bill. Plus, if interest rates rise, you don't have to worry about
your monthly mortgage payment rising accordingly.
disadvantage is that if mortgage rates go down and you'd like to capitalize on
this, you'll have to refinance — and that means spending a few thousand dollars
in closing costs. Fixed-rate mortgages also have higher starting interest rates
than adjustable-rate mortgages, and that may limit how much home you're able to
How adjustable-rate mortgages work
the name implies, adjustable-rate mortgages (ARMs) have interest rates that
change over the lifetime of the loan. Most ARMs these days are hybrids, which
means they have an initial fixed-rated period, after which the interest rate
begins to change, usually once per year. You may see this written as 5/1 or
7/1. This means that you get five or seven years of a fixed interest rate, and
after that, the interest rate — and your payments — will be adjusted every
risks of ARMs are clear. When your interest rate can change, it's possible that
your payments could become so expensive that you can't keep up with them. If
your monthly payments during the initial fixed-rate period would put a strain
on your budget, an ARM isn't a good choice for you. Before taking out an ARM,
be sure to get a Truth in Lending disclosure from your lender, which should
list the maximum amount your monthly mortgage payment could reach. Make sure
you're comfortable with this amount before you sign on the dotted line.
there can be times when an ARM is the smarter choice. Starting interest rates
on ARMs are usually lower than on fixed-rate mortgages, so your monthly
payments will likely be lower for at least a few years. And if you find
yourself in an environment where mortgage interest rates are declining or
holding steady, your interest rates may not increase significantly even after
the fixed-rate period is up.
interest rates begin to decline, your monthly payments may actually decrease,
though not all ARMs allow this, and they often put a cap on how low your
payments can go. Typically there are also caps on how much your payments can
increase, both annually and over the lifetime of the loan. You may see this
written as 2/2/5 or something similar. The first number reflects the greatest
amount by which the interest rate can rise in the first year after your fixed-rate
period ends — in this case, 2%. The second number represents the most it can
change every year thereafter, and the third number represents the most it can
change over the lifetime of your loan.
put this in perspective, let's say you buy a $250,000 home with a 30-year 5/1
ARM, a 4% initial interest rate, and 20% down. Your initial monthly payment
would be $955. In an ideal world, that number wouldn't increase over the
lifetime of the loan, and you'd get the whole house for about $344,000,
factoring in interest.
that's nearly the best-case scenario. Now let's consider the worst-case
scenario. Imagine that, after the initial fixed-rate period, your interest rate
rose by 0.25% each year until it reached the maximum increase of 5%, bringing
your interest rate to 9%. You'd end up paying $419,000 over the lifetime of the
loan, and your monthly payment would climb to $1,323.
are extreme scenarios, and in reality, the price you ultimately paid for your
home would likely fall somewhere in the middle. However, you should keep in
mind that if your ARM's interest rate reaches its cap, it could cost you tens
of thousands of dollars in additional interest payments.
Which type of mortgage is right for me?
Fixed-rate mortgages are
usually the better choice for most people. This is especially true if you plan
on being in your home for more than five years or if interest rates are
historically low, as they are now.
You may want to
consider an ARM if you'll only be in the home for a few years, if you think
interest rates will decrease, and/or you expect your income to rise enough to
absorb higher mortgage payments. Before you sign up for an ARM, though, it's
important to calculate how much your mortgage payment could change over the
lifetime of your loan to make sure it's still something you could afford.
To view the original article click here