Adjustable Versus Fixed Rate Mortgages

One of the biggest decisions that you will have to make when buying a home is whether to take out a fixed rate or an adjustable rate mortgage.  A fixed rate mortgage results in steady monthly payments over the life of the loan.  An adjustable rate mortgage gives you an initial interest rate that is lower than a fixed rate mortgage.  However, this interest rate is only fixed for a certain period of time, then the interest rate along with your monthly payments may go up or down.

Common adjustable rate mortgages include mortgages with a low fixed rate for: 1, 3, 5, 7, & 10 year periods.  The shorter the period of time that the interest rate is fixed for, the lower the rate will be.  Which adjustable rate mortgage, if any, is best for you depends upon various factors including how long you intend to own the home and if you will be able to financially manage a substantial increase in monthly payments should the interest rate go up.

 
For example, if you only intend to live in a home for 3 years, then a 3-year adjustable rate mortgage may be right for you.  This is because you will save money by having the adjustable rate mortgage rather than the fixed rate.  If you were to take out a $250,000 fixed rate mortgage at 6.00% for 30 years your monthly payment would be $1498.88.  Over 3 years that would be $53,959.68.   However, if you chose a 3 year adjustable rate mortgage for $250,000 at 5% your monthly mortgage payment would be $1,342.05 or you would pay $48,313.80 over 3 years.  As you can see, if you chose a 3 year adjustable rate mortgage rather than a 30 year fixed rate, you would have saved $5,645.88 over 3 years.

Since most people move every 7 or 8 years an adjustable rate mortgage may be right for them.  An adjustable rate mortgage makes sense for those who are fairly certain that they will NOT own the home for more than a certain number of years.  It also makes sense for those who want to live in a home for a long period of time but cannot manage the higher payments on a fixed mortgage at this time. 

A good example would be a doctor who is doing his residency.  The doctor may not be earning a large salary because he is early in his career.  However, he is certain that his salary will increase substantially after his residency is over.  Therefore, a low initial fixed rate will be a great option because if the monthly payments increase substantially then he will be able to make the increased payments because his salary will have grown.

Adjustable rate mortgages are probably wrong for you if you are buying a home that you plan on living in for a very long period of time or if you will be unlikely to financially be able to pay the mortgage payments should the interest rate increase substantially when the mortgage shifts from a fixed to adjustable rate.   You must also ask yourself are you using an adjustable rather than a fixed rate mortgage to buy a home that you really can NOT afford.

As with most decisions in the home buying process, you should evaluate your current and future financial situation and plans and your risk tolerance.  The best time to do this is well in advance to the emotionally frenzied home buying process.

Feel free to contact Kane Realty Advisors today to discuss all of your finacing options.