Should You Pass On The Fixed Rate Mortgage?

Written by Posted On Friday, 15 November 2013 11:19

Back in 2004, Federal Reserve Chairman Alan Greenspan famously dissed the fixed-rate mortgage, suggesting that many homeowners were overpaying for their homes and that lenders should offer more alternatives in financing.

We all know what that led to – the subprime and no-doc mortgage securities fiasco that caused the nation’s economy to collapse into the most protracted recession in history.

Along with stocks that pay dividends, the stodgy fixed rate loan fell victim to the new economy thinking - risk gets better returns than safety.

Now that we’ve returned to our senses, fixed-rate loans are top choice for borrowers again. But is the fixed rate mortgage the right choice in every case?

Thirty year fixed rates are typically a point or two higher than the 5/1 adjustable rate mortgages. That could translate to as much as a couple of hundred dollars per month, depending on the size of the loan.

The typical homebuyer in 2013, according to the National Association of REALTORS® plans to occupy their home for 15 years, but the reality is that they’ll stay nine years. For them, the fixed-rate mortgage is perfect, but what if a buyer plans to move in five or seven years?

The adjustable rate mortgage may be the answer. A 5/1 ARM offers a fixed rate for five years, then rolls over to an adjustable rate that reflects market conditions at that time. The rate then adjusts once a year, up or down, depending on the vagaries of the 10-year Treasury note and other instruments. ARMS come with caps, which means that the rate will not adjust more than two points above each reset and more than six to seven points for the life of the loan.

Since 2002, fixed rates fell by more than half, testing all-time lows again and again. Now they’re climbing again, but slowly.

Basically, the longer the term, the more risk for the bank. The shorter the term, the more risk for the borrower.

Ask your lender to show you the numbers - what will your loan look like in five years, seven years, ten years. If you can afford a fixed rate but choose an adjustable rate, make the payment difference to your mortgage principal, and you’ll build equity faster, allowing you to sell in five years with a little more in your pocket.

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Blanche Evans

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