Should you get a fixed rate mortgage?

By March 23, 2015Loan Talk

With Record Low Interest Rates Should You Get a Fixed Rate Mortgage?

The last three years have seen the lowest mortgage rates found in decades. With interest rates positioned to rise in 2015, this is a great time to buy a home. Housing prices are still suppressed in many areas, yet trending upward. This provides the perfect storm for buyers to purchase a property at low prices, while enjoying record low interest rates.

It is tempting in this environment to lock into a 30 year fixed rate when the time comes to make your purchase. After all, that is what most borrowers do. Yet this strategy may not get you the lowest possible rate or payment.

Considering that interest rates have such a significant impact on the house payment, evaluating all your loan options will help you get the best deal.

Loan Options

30 Year Fixed Rate Loan will offer the same rate over the entire 30 year loan. The principle and interest will remain the same with only the escrow payment changing from year to year, which covers taxes and insurance. As these costs rise, your escrow payment will increase to accommodate the higher costs.

If you plan to remain in your home for 10 years or longer the 30 year mortgage is a great option.

15 Year Fixed Rate Loan will offer the fastest payoff, but the highest payment. While the interest rate for the 15 year will be lower, because the time period is cut in half the overall payment will be higher.

If you want to retire early and be mortgage free before you retire, then the 15 year loan is the best option. It may require you to purchase a less expensive home, but to live mortgage free after 15 years may be worth the sacrifices.

5/1 ARM is a 5 year adjustable rate mortgage. The rate remains the same for the first 5 years and then will adjust every year afterwards. The ARM is amortized over 30 years with an introductory fixed rate that is significantly lower than the 30 year fixed. The terms on each loan will depend on the lender, but generally the variable rate is tied to either the prime rate or LIBOR rate. When the rates adjust they can go up or down. Generally they can only rise by 1 or 2 points a year and there is a maximum it can rise over the life of the loan, which is commonly 5 points.

If you plan to live in the home 5 years or less, this option will offer the lowest interest rate and the lowest mortgage payment. You have the option of benefiting from the lower payment or purchasing a more expensive home.

7/1 ARM is a 7 year adjustable rate mortgage. This loan will work exactly like the 5 year ARM but gives you 2 more years of a fixed rate before the rate begins to fluctuate annually.

If you are planning on living in your home 7 years or less, this option will offer a lower rate than the 30 year fixed.

A chart to illustrate the monthly payment differences might look something like this:

 

Loan TypeInterest RateLoan AmountMonthly Principle and Interest PaymentAnnual Payments
30 Year Fixed3.90%$500,000$2,358.34$28,300.08
15 Year Fixed3.15%$500,000$3,489.09$41,869.08
5/1 ARM3.22%$500,000$2,167.81$26,013.72
7/1 ARM3.44%$500,000$2,228.51$26,742.12

Rates are based on current rates at Bankrate.com. They are used for hypothetical purposes only to represent monthly payment differences.

This chart illustrates the annual payment difference between the different loan options. Here the difference between a 30 year fixed and a 5 year ARM is $2,286.36 per year (which is like making an extra payment). This figure adds up to over $10,000 in savings over a 5 year period of time. If you are only going to be in the home for a few years, it is worth considering options outside of the traditional 30 year fixed loans.

Other options like interest only loans can keep the monthly payment down even further but take on a lot more risk as the rates can fluctuate monthly, and negative amortization can occur.

When meeting with a lender, consider all of your loan options. Regardless of the loan program you choose, you can choose to finance with either a fixed or variable rate loan.

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