In addition to choosing among many types of mortgage products, such as conventional or FHA, you also have choices in setting up the interest rate to finance the home. Broadly, there are two types of interest rates with a lot of varying factors for both types, fixed and adjustable.
When it comes to which kind of rate you want, we ask you to consider two things regarding fixed and adjustable:
- How long you plan to stay in the house, and
- Your risk tolerance.
What Do Fixed and Variable Mean?
Fixed means the same and safe, while variable means change and risky. If you are planning to stay in your home a long time, you would rarely consider a loan other than a fixed-rate home mortgage. If you will likely move within seven years, then the ARM (adjustable rate mortgage) will save you money. About 12 percent of all home loans are ARMs, or adjustable rate mortgages.
Fixed-rate loans are usually about 1.5 percent higher than an adjustable rate or variable loan. (The terms variable mortgages and adjustable rate mortgage mean the same thing.) With an ARM, the rate remains fixed for three, five or seven years and then can adjust every year. For example, if it is a five-year adjustable rate mortgage, this loan is called a 5/1ARM (five years fixed, then adjustable on each one-year anniversary of the loan after that).
Adjustable Rate is a Bit of a Gamble
With a fixed rate loan, if you stay in the house and rates go sharply higher, your interest rate will not change and you will come out ahead. With an adjustable rate mortgage, if you stay in the house and rates go sharply higher, your interest rate will increase accordingly, and whoever owns your loan will come out ahead. This is why mortgage lenders can offer a lower rate for an adjustable rate mortgage. The lender is hedging its bet by setting a time limit on the guaranteed lower rate. After that, if current rates are higher, your rate will go up. Again, you’d lose. It’s a bit of a bet and that’s why we ask you to consider your tolerance for risk.
While there are online calculators to advise you, they generally require a lot of detailed information. You can play around with our Instant Rate Quote calculator and Monthly Payment calculator to explore the differences.
Adjustable Rates are All About Timing…
We at Carolina Home Mortgage generally advise our clients based on how long they will be in the home, but there are many factors to consider. For example,
- Investment Money. If you have a lower interest rate with an ARM, you will have more money on a monthly basis to invest or spend.
- Pricier House. Lenders can generally qualify home buyers for a larger house if the buyer applies for an ARM.
These are tempting factors! We suggest you seriously think about how long you will be in the home. Consider if it is your first home, you are more likely to move than not.
And Risk Tolerance
The second factor, risk tolerance, is the term we use to describe the chance you are taking on future interest rates. You are betting that you will move before your rate increases or that you will be able to refinance the home to a fixed-rate loan before the rate goes up on an ARM.
Hint: If the interest rate on your ARM is, indeed, 1.5 percent lower, you will save 7.5 percent on the loan amount in interest expense over the first five years. But it is likely that starting with year seven or eight, the 5/1ARM will become, overall, a more expensive loan than the 30-year, fixed-rate loan. While there is often a limit on how much the rate can increase, a 4 percent interest rate can increase to 9 percent in just three years depending on the economy.
According to Realtor.com, “ARMs are difficult to understand. Lenders have much more flexibility when determining margins, caps, adjustment indexes and other things, so unsophisticated borrowers can easily get confused or trapped by shady mortgage companies.”
It’s Not Your Father’s Fixed Rate
Historically, there was a 30-year fixed-rate mortgage, and that was about it. Today, however, you can choose between 10-, 15-, and 30- year mortgages. It’s fun, too, to look at historic rates for fixed mortgages and see years of double digit interest rates. If you’re a history buff, you can access Freddie Mac’s history of the Fixed-Rate Mortgage here.
Why Work With Us?
Carolina Home Mortgage is local and an independent small business. You’ll find our rates are low if you do the comparison. For 15 years we have helped clients become our neighbors You don’t get to do that unless you offer quality and client-centered service.
Email your questions to
info@carolinahomemortgage.com
or call us. At the end of the day, we report to you, not the bank. We are available after hours and weekends, too!
