When Borrowers decide to lock in their fixed-rate mortgage, they are guaranteed that rate whether the Lender's interest rates increase or decrease. I discussed how rates are determined in an earlier blog, Current Interest Rates Mean More House for Buyers Rates will fluctuate based on the market and Borrowers need to decide when they want to lock in or set their rate.
One of the most common questions I get from Borrowers is "Should I lock in now or float?" There is no crystal ball to let Lenders or Borrowers know if locking in early is a good decision. I cannot give a definite answer because a rate can rise or decrease (multiple times!) from when a Borrower applies for a mortgage until the time they are at the settlement table. Unless you are in the mortgage industry, you might not realize that rates actually change a few times a day. It’s similar to the stock market, you can follow the analysts, but no one can predict with 100% accuracy.
So, what are your options? Outside the US, variable-rates mortgages are the norm, especially in countries such as the UK, Ireland, Canada, and Australia. The majority of mortgages in the US are fixed rate, however ARMs should be considered by some borrowers
The Good: Most ARMs provide a cap, so this safeguards or limits the risk to the borrower. In the end, Lenders want Borrowers to pay back their loan, so there is a limit to how much risk they want the borrower to absorb. Current caps are still much lower than normal fixed mortgage rates were 10 years ago. Moreover, Borrower’s initial payments will be lower, giving them more buying power and the ability to afford “more house”.
The Bad: Adjustable rate mortgages or ARMs transfer the interest rate risk from the Lender to the Borrower. The Borrower will benefit if the interest rate falls, but could lose if the interest rates increase. Borrowers should avoid ARMs if they play on staying in their home 11 years or more or if there is little chance rates will ever drop.
The Truth: The risk might be worth it! Overall adjustable rate mortgages are typically less expensive than fixed-rate mortgages. ARMs are a great way to get the house you want now before you can afford higher payments. Consider this scenario: You are working at a company what will increase your pay as soon you receive your Master’s Degrees. You are less than a year ago from getting your degree and need to move for your spouse’s new job. Instead of getting a small house and then looking for another house after your pay raise, it is more cost-effective to move once and get an ARM. You know your pay will increase within the next year or so, meaning you can support an increase payments IF rates change in five years. Most ARMs have an initial fixed-rate period during which the borrower’s rate doesn’t change, followed by a period during which the rate changes at present intervals. Compare the two choices below for a house worth $288,000:
Option 1: 30 year fixed rate Mortgage at 3.625%. Principal and Interest payment $1,313.43
Option 2: 5/1 ARM at 2.625%. Principal and Interest payment $1,156.75
Balance remaining in 5 years:
30 Yr fixed: $259,408.54
5/1 ARM: $254,865.49
Winner: Principal balance on the 5/1 ARM is $4,543.05 lower
Best part is your monthly payments will have totaled $9,400.80 less for a Net savings of $13,943.85!
I would recommend ARMs for buyers when their income is expected to increase, they are likely moving in 10 years or less, or plan on retiring and paying off home within 10 years. In reality, ARMs benefits a large segment of the population if you consider the fact that 91% of the mortgages are in place 9 years or less. Read all the fine print closely to make sure your ARM does not have pre-pay penalties, provides caps on the rate, and the interval rate changes are when you can afford the possibility of a higher payment. It comes down to being an informed consumer and knowing what your plan is for the next five years. If you know that, you have the potential to save a lot of interest on your mortgage. ARMs may seem risky at first glance, but they really can benefit certain Borrowers. When in doubt, have your Mortgage Broker compare fixed and adjustable rate options so you can see the full picture.
