Buying A Home - Fixed Rate or Adjustable Loan

By
Real Estate Agent with Coldwell Banker Preferred Properties

Interest Rates are really low right now, and we've been talking about 30 and 15 year Fixed Rate Loans. If you look at the different loan programs that lenders are offering, you will also hear about Adjustable Rate Loans.  Adjustable Rate Loans typically have a lower rate than the fixed rate initially and can look really attractive (and can help you afford a more expensive house).  Sounds like a great deal, but you need to really look at the total picture before getting into an adjustabel rate loan.

The FIXED RATE LOAN is based on what the current rate is and your loan repayment amount is set at the same amount for the life of the loan (most commonly 15 year or 30 year repayment).  The payment includes an amount that pays down the principal (the amount you borrowed) and the interest that accrued on that principal balance. The more payments you make, the less you owe on the loan so each month the amount you apply to principal increases and the amount you pay in interest decreases. But the PAYMENT remains the same. Usually added to your monthly payment is an amount for taxes and insurance which can go up each year based on whether the tax assessor or the insurance company raises the amount due to them, but your monthly payment amount remains the same. 

With an ADJUSTABLE RATE LOAN, the payments can adjust or change over the life of the loan.  There are two components, first the frequency (how often it changes) and 2nd, the amount of change.   Typically, the rate will change on a yearly basis (a One Year ARM will change every year).  Some loans have a set rate for the first few years - perhaps fixed for 5 years then it will adjust every year after that. So, if you started out with an interest rate of 5.5% and your loan is a 5/1 ARM, it will be fixed for 5 years at the 5.5% rate and then on the 5th year anniversary of your 1st payment, your payment will change and continue to change every year after that.

What will it change to?  That depends to what "index" your loan is tied to.  What is an index?  There are several different types of money rates in the open market.  These rates change every day. Their numbers are published and they are pretty easy to track. Some commonly tied to mortgages are the T-Bill, the FNMA Security Rate, the 7th District Cost of Finds. Once you know your index you also need to know your margin.  The margin is the amount OVER the index you will pay.  So, if your margin is 2%, then your new payment rate will be the index rate plus 2%.  So, if today the 7th District Cost of Funds rate is 6%, your new rate will be 8%.  If you started out at 5.5% and then it's time for your rate to change and it goes to 8% - Wow that is a huge adjustment in your payment.  Say you had a 100,000 loan at 5.5%, your loan payment (not taxes and insurance) would be about $568. At 8% the amount would be $734.  That would be an increase of $168 per month.  Not to mention the fact that taxes and insurance go up on a regular basis.

In the news we've heard that people's payments have been going up on their adjustable rate mortgages - this has contributed to people losing their homes to foreclosure.  Adjustable rate mortgages are nothing new.  In fact the same thing happened back in the 80's when rates went up and people couldn't afford their payments.

Many people rationalize that they KNOW their salary will go up later so they'll be able to afford it.  That is not always the case and you might want to buy a new car or furniture.  The safest way to go is with a fixed rate - even if it is a little higher to begin with.

If you would like any additional information about Buying a Home in Hoover, AL, I'd be happy to help you.  Contact me at www.ToniBird.com.

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Rainmaker
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Richard Byron Smith, NMLS #184479
Mortgage Loan Officer, Fairway Independent Mortgage Corporation NMLS #2289 - Chattanooga, TN
Mortgage Loan Officer

Toni,

Great information that always needs repeating.

Another helpful note is that generally the fully indexed rate is higher than the comparable fixed rate offered at the time of the adjustment.

With some ARMS there is an initial "teaser" that is lower, but they make no sense to me with the fixed rates that are available in today's market.

When rates are above historical averages, adjustables may be a good choice, because over the term it is likely that the rate will be lower. With rates this low, it is not likely that the rate will drop.

The ARM borrower will likely have much higher rates, even the short term buyer.

Just my opinion.

Good post.

Love that logo on the bottom right. Classy nice touch. It should link to your site, and have an alt tag.

Richard

Sep 14, 2008 01:50 PM #1
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Rainmaker
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Toni Bird

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