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Along with other decisions your clients will find themselves making while shopping for a
mortgage, they will be deciding whether to take a fixed-rate mortgage (FRM)
or an adjustable rate mortgage (ARM).
As the name implies, the interest-rate of an FRM will remain the same
throughout the life of the loan. If interest rates are low when you are buying
or refinancing a home, an FRM is a good choice, because you can lock in that low
interest rate. ARMs, however, will fluctuate as interest rates rise and fall.
Your 6 percent rate today could drop to 5 percent next year or end up at 8
percent if the market rate goes up.
Exactly when the rate of your ARM loan will change depends upon the terms of
your loan agreement, which could see rates change every three months, once a
year, every three years, or not until five years. It’s not uncommon to find
ARMs that start at a fixed rate and convert to an adjustable rate after several
years.
ARMs also generally come with a "cap," which limits the amount a
lender can raise its rate. The cap for most ARMs is 2 percent, meaning a lender
can only increase its rate 2 percent within a single adjustment period. But
several adjustments can turn a 4 percent interest rate at the beginning of the
loan into a 10 percent interest rate later on.
As you might imagine, FRMs are more popular. Most home buyers want the
security of knowing how much their mortgage payment will be each month. An FRM
will allow you to more easily manage your monthly and yearly budget. If you have
an FRM and rates do drop precipitously, you can always refinance.
On the other hand, some homebuyers are drawn to ARMs, which often feature
lower initial interest rates. For example, an ARM can be a good choice for a
young couple purchasing their first home; they may not have a lot of assets now,
but they anticipate making more money within a few years. An ARM can let them
take advantage of low rates now, and they will be able to afford a slighter
higher rate in the future. And in a few years, they can refinance with an FRM to
lock in a favorable rate.
Which type of mortgage is right for you? Basically, it comes down to two
factors:
1. How comfortable you are with risk
2. How long you plan to live in the house
Clearly ARMs are riskier than FRMs. But taking on more risk may result in a
lower rate -- at least temporarily. But if you plan on staying in the house for
a long time, an ARM can be particularly risky -- and potentially confusing --
since rates will fluctuate many times over and there will be more adjustments.
Conversely, if you plan to move after five or six years, you could take a 5/1
ARM, meaning the first five years are locked in (at a low rate) and it converts
to an adjustable rate after that -- right about the time you plan to sell.
Information
courtesy of Yahoo, Business Week and Entrepreneur
The purpose of this
newsletter is to stimulate thought for our
clients and professionals with whom we network. One should consult with a qualified
financial planning professional prior to
implementing any financial
planning
strategies. If you are a legal,
insurance, real estate or mortgage professional receiving this newsletter or know of one,
please contact our office to introduce
yourself and your services to us. We
are always seeking to grow our referral
network and expose professional services
to our client base.
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