Adjustable Rate vs Fixed Rate Mortgage
A lot of people got fooled in the thunderous housing crash in 2008-2009 with adjustable rate mortgages. When facing the jigsaw puzzle of choices for a mortgage while buying a house, does that mean the choice between an adjustable rate vs fixed rate mortgage is over? Here’s the twist, maybe the choice should be based on your circumstances. Making the wrong choice will have you singing like the Piano man, “If I could get out of this place.”
For example, a five-year ARM only has a fixed rate for the first five years; then the rate adjusts once per year for the next 25 years. This fixed rate be a great option if you plan to be in the house for five years or so.
Zillow wrote, “Many home buyers focus on finding the lowest mortgage rate at the time they’re buying their home, and a five-year adjustable rate mortgage (ARM) often looks quite appealing to them. But it’s important to understand that an ARM rate adjusts at the end of the initial term. For longer time periods, the risk of a five, seven, or even 10-year ARM is too great, given future rate adjustments, which can cause your monthly payment to spike. That is exactly what happened and led to many foreclosures. The homeowner was not able to make the increased monthly payments.
Adjustable Rate vs Fixed Rate Mortgage
If you are going to be in the house for longer than five years, I like to let the bank assume the risk of fluctuating interest rates. When you take out a mortgage for fifteen or thirty years, you lock in that rate, betting that interest rates are going higher and the bank who borrows short and lends long to you will face the interest rate risk. If interest rates go down, though it is hard to believe mortgage rates could go a lot lower, you get to refinance.
Zillow suggests a better option is a 15-year mortgage. The rate is the same as a five-year adjustable, but since you are amortizing the mortgage in 15 years, the payment is higher than a five-year adjustable.
Here are the payments for each type of $300,000 mortgage. (These examples are mortgage payments only, excluding taxes and insurance.)
- 15-year fixed payment: $1,686
- 30-year fixed payment: $1,129 ($557 lower than the 15-year payment)
- 5-year ARM payment: $1,044 ($642 lower than the 15-year payment; $85 lower than the 30-year payment)
If your budget can accommodate the higher payment on the 15-year loan, not only will you pay your loan off early, but your interest rate is .625 percent lower, saving you $102,732 in total interest paid over the life of the loan.
Even better, if you make an extra payment of $300 each month, you can pay down the mortgage faster. For example, a fifteen–year mortgage can be paid off in 5 years and three months with an extra $300 a month; an extra payment of $400 each month reduces the fifteen-year mortgage to three years and four months.
That’s not all.
You would save $59,781 in interest when you pay $300 extra and $70,949 with an extra $400 per month. To me, and I hope to you, that’s big money.
Terra Firma Property Solutions, LLC is a professional, full-service real estate solutions firm that buys and sells properties throughout the greater Kansas City area. We specialize in buying distressed homes, then renovating and reselling them to home buyers and landlords. Terra Firma Property Solutions is excited to be part of the economic rejuvenation of Kansas City and its surrounding areas.
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