A lot of people got hurt in the housing crash in 2008-2009 with the adjustable-rate mortgage. Does that mean one shouldn’t consider an adjustable-rate mortgage? Maybe the choice is based on your circumstances.
For example, a five-year ARM only has a fixed rate for the first five years; then the rate adjusts once per year for the next 25 years. This could be a great option if you plan to be in the house for five years or less.
Zillow wrote, “Many home buyers focus on finding the lowest mortgage rate at the time they’re buying their home, and a five-year adjustable-rate mortgage (ARM) often looks quite appealing to them. But it’s important to understand that an ARM rate adjusts at the end of the initial term.” If there is a possibility that you stay in the house for more than five years, the risk of higher loan rates could spike your monthly payment. That is what happened and led to many foreclosures. The homeowner was not able to make the increased monthly payments.
If you intend to live in the house for longer than five years, I like to let the bank assume the risk of fluctuating interest rates. When you take out a mortgage for fifteen or thirty years, you lock in that rate, and the bank that borrows short term will face the interest rate risk. If interest rates go down, though it is hard to believe mortgage rates could go a lot lower, you get to refinance. To refinance, you should always consider the cost. A typical refinancing will cost you 2 to 5% of the loan amount.
Zillow suggests a better option is a 15-year mortgage. The rate is the same as a five-year adjustable, but since you are amortizing the mortgage in 15 years, the payment is higher than a five year adjustable. You could choose a thirty-year mortgage at a lower interest rate, but most homeowners sell their house I five to seven years.
Here are the payments for each type of $300,000 mortgage. (These examples are mortgage payments only, excluding taxes and insurance.)
If your budget can accommodate the higher payment on the 15-year loan, not only will you pay your loan off early, but your interest rate is .625 percent lower, saving you $102,732 in total interest paid over the life of the loan.
Even better, if you make an extra payment of $300 each month, you can pay down the mortgage faster. For example, you can pay off a fifteen-year mortgage in 5 years and three months. An extra payment of $400 each month reduces the fifteen-year mortgage to three years and four months. That’s not all. You would save $59,781 in interest when you pay $300 extra and $70,949 with an additional $400 per month. To me and I hope to you, that’s big money.
Your credit score is one of the most important factors when applying for a mortgage. It influences your monthly mortgage payment, the total amount of interest you pay on your mortgage loan, and ultimately the total amount you pay for your home. Because your credit score dictates your interest rate, you should make sure your credit is in the best shape possible before applying for a mortgage.
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