By Dian Hymer
Today's low interest rates make 30-year fixed-rate mortgages pretty attractive. But, is a 30-year fixed-rate mortgage the best way to go? What about an ARM (adjustable rate mortgage); a 5-year fixed; a 5/2/5 or even a 15-year fixed? With so many mortgage products to choose from, how do you decide which is best for you?
Assuming you have no problems qualifying for a loan, the decision will depend on your personal goals as well as your tolerance for risk. An ARM is riskier than a fixed-rate loan because the interest rate and monthly payment might go up over time. Borrowers who have a low tolerance for risk, or who are on a fixed-income, often prefer a fixed-rate mortgage with an interest rate and monthly payment that won't change.
The length of time you plan to stay in your home should weigh heavily in your decision. If you're sure that you won't be moving for seven to 10 years, a 30-year fixed-rate loan might best suit your needs. These mortgages are currently available in the 5 percent range.
But borrowers who are sure they'll be moving within the next five years will save money with a 5-year fixed-mortgage product. These are currently available in the 4 percent range. For the first five years, the interest rate is fixed. Then the mortgage converts to an ARM.
The specifics will vary from one 5-year fixed product to another. A common variety is called a 5/2/5 mortgage. The interest rate is fixed for the first five years. After that, the rate adjusts. The rate can only move up 2 percent in any one year. And over the life of the loan, the interest rate cannot rise more than 5 percent from where you started.
So, if you started at 4 1/4 percent and interest rates rose to 12 percent, the most you'd ever pay would be 9 1/4 percent. However, on the first adjustment only, the rate can adjust up the full 5 percent allowed if the index the ARM is tied to has gone up 5 percent or more since you took out the loan.
Today, it's hard to imagine that interest rates will ever hit 9 percent again. But 20 years ago, we were sure we'd never see rates drop below 10 percent. Interest rates are expected to stay low for some time. However, financial markets can change quickly, and without warning.
House Hunting Tip: For this reason, it's a good idea to consider the worst-case scenario before choosing a fixed-rate ARM. Suppose you don't move at the end of five years as you thought you would. Calculate how much the loan will cost you if interest rates were to skyrocket during the fixed-rate term of the loan and you ended up paying the maximum rate allowed for several years.
Fully adjustable-rate mortgages are available in the 3 percent range. Many of these loans adjust monthly. Although riskier, these loans are popular with borrowers who need financial relief. These loans are also the easiest to qualify for. Some ARM products even allow the borrower to make a reduced payment in lean financial times.
The 15-year fixed loans are popular with borrowers who think they want to own their homes free of any debt. These loans are harder to qualify for because of the higher monthly payment.
The Closing: A 30-year loan offers more flexibility than a 15-year because you're not locked into a higher monthly payment. But, you can always pay more on a 30-year loan if you want to pay it off faster. Just make sure the loan doesn't have a prepayment penalty.
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