One of the issues that anyone buying or refinancing a home faces is whether to structure the loan with a long-term fixed product (like a 30 year fixed) or with an adjustable rate mortgage (ARM). Today, for example, someone buying a $450,000 home with 20% down could choose between a long-term fixed rate of about 4.875% at the same cost of a 7-year ARM at 3.75%. The principal and interest payment on the 30-year fixed would be about $1900 / month for 30 years and the principal and interest payment on the 7-year ARM would be about $1670 / month for 7 years. Is the $230 / month savings worth “losing” a long-term fixed rate?
While many variables could impact the analysis of this question, there is really ONE major factor at stake – how long does the homeowner plan to stay in the home or the loan? If someone expects to be in a home or particular loan for more than 10 years, choosing a long-term fixed rate may be your best bet. However, if the homeowner expects to be in the home for less than 10 years, an ARM is probably the best bet.
The fact is that most homeowners refinance or move every 3-5 years. How many people do you know that have a 30 year mortgage and kept it for 30 years? It rarely happens. In fact, 30 year fixed rates are historically bench-marked against the 10-year Treasury because mortgage investors anticipate most 30-year fixed mortgages to be paid back through a refinance or a sale in 10 years or less!
There is no doubt that having a 30-year fixed rate gives a certain peace of mind – and that is worth a lot. However, borrowers should put a price tag on their peace of mind. In the above example the homeowner would save almost $20,000 over 7 years by going with the ARM. That $20,000 could be put to work in investments, paying off other debts, or paying down additional principal. Why leave $20,000 on the table unless you’ve found the dream home you plan on living in forever?
It is always best to have a mortgage professional walk you through your options and talk about the different risks and rewards associated with different products. If you’re not a finance wizard, this is not a “do it yourself” project! Always seek good counsel when making major financial decisions.
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