Yale Roth M.A., M.Ed

Posts Tagged ‘fixed rate mortgage’

To answer the mortgage question: “Which is a better loan type: a fixed rate mortgage or adjustable rate mortgage?” it’s important first to define each loan type first.

What is a fixed rate mortgage?

A fixed rate mortgage is based on a fixed mortgage rate that doesn’t change through the term of the loan.  The mortgage is amortized based off that mortgage rate and mortgage term.  The mortgage will be paid off and satisfied at the end of the mortgage term.

So, for example, on a 10 year fixed mortgage, if the mortgage rate is 3.5%, that 3.5% mortgage rate won’t change.  Also, at the end of 10 years, the mortgage will be paid off.

Here are benefits of a fixed rate mortgage.

1. The mortgage rate is fixed so you know what your’re being billed at, no matter where the mortgage rates are.  So, if you’re locked into 3.5%, if the prevailing mortgage rates are 7%, you’re secure at 3.5%.

What is an Adjustable Rate Mortgage also known as an ARM?

An adjustable rate mortgage ARM offers a mortgage rate that is fixed for a certain amount of time: either 3, 5, 7, or 10 years.

After that fixed period is up, the mortgage rate adjusts to the yield on a specific index.  In addition to the yield on the index, there will be a “margin” attached to the yield.  The margin varies from 2.25% to 2.75%, usually.

So if the yield on the index after your fixed period is up is 4.1% – let’s say – we add the margin of 2.25% – let’s say – to get a “bill rate” of 6.35%.

This will be the mortgage rate that you’ll be billed at for 1 year after the fixed period lapses.

One year from the first adjustment day, the mortgage will do the same thing all over again – look at the yield on the index and add the margin to it.  That will be your bill rate for the next year.  The mortgage rate will continue to change every year thereafter until the term is satisfied.

There are mortgage rate caps that are placed on the adjustable rate mortgages.

For example, a common “cap structure” is what’s called 5/2/5.

That means that the most your mortgage rate can increase to after the fixed period lapses is 5% over the initial start rate.  This is also the lifetime cap on the mortgage.

So if your start mortgage rate is 3.5%, the most the mortgage rate can increase to through the lifetime of the loan is 8.5%.

Adjustable rate mortgages ARMs are amortized over a 30 year period.

The index that are tied to the adjustable rate mortgages is typically the LIBOR index.  LIBOR stands for the London Interbank Offered Rate.

What’s the benefit of the adjustable rate mortgage?

If you know that you’re only going to own the home for a specific amount of time, like 5 years, you may want to consider an adjustable rate mortgage because the mortgage rate will be lower than the 30 year fixed mortgage rates.

With the lower mortgage rate and lower mortgage payment, you’re saving money from a monthly cash flow perspective.

The draw back of the adjustable rate mortgage ARM is that the mortgage rate and mortgage payment can change after the start rate period lapses.

To answer the mortgage question “are you better off with a fixed rate or adjustable rate mortgage” it just depends how long you plan on keeping the home, what the monthly savings is by going with the adjustable rate mortgage and whether that savings and mortgage affordability justifies the risk that the mortgage rate can change after a certain amount of time.

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Out of all the mortgage questions I get, this mortgage question is asked every now and again: “Are Adjustable Rate Mortgages That Bad”?

When determining what loan type someone is interested in, I ask, “Are you looking for a fixed rate mortgage or an adjustable rate mortgage.” Typically I get the answer, “No way do I want an adjustable rate mortgage.”

Adjustable rate mortgages, also known as ARMs, are not necessarily bad loan types.  It just depends what your objectives regarding the mortgage are.

Here’s a breakdown of the pros and cons.

The Pros.

1. Often times the mortgage rate and mortgage payment are lower than the fixed rate mortgage, especially the 30 year fixed mortgage.

2. The lower mortgage rate will provide additional monthly savings – in comparison to the 30 year fixed mortgage.  Cash is king.  It’s critical to save that difference; don’t spend it or get into the loan because you cannot afford a 30 year fixed rate mortgage payment.

The Cons.

1. The mortgage rate and mortgage payment can adjust after a certain amount of time. The fixed amount of time can range from 3 years to 10 years.

Why Would You Want An Adjustable Rate Mortgage ARM?

The reason people get into these loan types is because they know they will be selling the home within a certain time frame – like 3, 5, 7 or 10 years. Given this, why would they want a 30 year fixed mortgage, which would offer a higher mortgage rate and mortgage payment?

So, if you know that you’re only going to be in the home for 5 years – say – and you can save $150 month on a 7 year adjustable rate mortgage in comparison to a 30 year fixed mortgage, consider the 7 year ARM. Take the difference that you’re saving in mortgage payment and save it or apply it to principal reduction.

For example, if you take $150 and save it for 5 years or 60 months, you’ll have saved $9000, without earning any interest.

Please note that I’m comparing adjustable rate mortgage payments (which are amortized over a 30 year period) to a 30 year fixed mortgage payment. To compare the adjustable rate mortgage payment to a shorter term loan like a 15 year or 10 year fixed isn’t good comparison because with the shorter term mortgages, you’re going to build equity in your home faster than you would with an adjustable rate mortgage (unless you pay additional towards principal reduction on the adjustable rate mortgage.)

If you want to build home equity faster, then a shorter term loan would be worth considering.

However, if you know that you’re only going to own the own for a short period of time and don’t care about building home equity but would rather save the cash, an adjustable rate mortgage is worth considering.

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To subordinate a 2nd mortgage is a mortgage question I get a lot from people who have a 2nd mortgage or a home equity line of credit and want to keep it open.

It’s a good mortgage question and here’s the answer: “It depends.”

In my opinion, a mortgage subordination depends on what type of 2nd mortgage you have and what your goals are regarding your home.

If your 2nd mortgage is a fixed rate second mortgage with a mortgage rate higher than the mortgage rate that you’re considering refinancing into and with a mortgage term of 30 years, then add your 1st mortgage and second mortgage payment together and compare it to a new proposed mortgage payment.

If you’re considering going into a 30 year fixed mortgage, then you want to compare the mortgage payments.

If the proposed mortgage payment is lower, then it would make sense to consolidate both 1st and 2nd mortgages into 1 new lower mortgage payment with a lower mortgage rate and not do the mortgage subordination.

If you’re 2nd mortgage is a home equity line of credit or HELOC, then it may not make sense to consolidate it into one new mortgage and – in that case - do the mortgage subordination.

This is what you need to consider:

1. What is the mortgage rate on the home equity line of credit HELOC?  It’s going to be tied to the prime rate, which is currently 3%, very low indeed.

Remember that the prime rate is variable and moves, so you’re HELOC payment can increase over time and there is no cap to the HELOC rate.

2. If you plan on keeping the home for a short period of time, then it would probably make more sense to subordinate the 2nd mortgage or home equity line of credit and just refinance your first mortgage.

If you plan on keeping the home for a while, then you may want to consolidate the home equity line of credit HELOC, close it, and refinance into 1 new mortgage at a low fixed mortgage rate and not do the mortgage subordination.

As long as you have equity in your property and you’re gainfully employed, you can reapply for a new home equity line of credit.

This way, you’re eliminating a mortgage that has a mortgage rate that has the potential to go up and fixing it into a low fixed rate mortgage.

If you want to keep the home equity line of credit open so you can access the cash in the event of an emergency, then you may want to do the mortgage subordination, allowing you to maintain access to the HELOC.

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I get a lot of questions about adjustable rate mortgages also known as ARMs.

The question I get the most is: “Should I take an adjustable rate mortgage (ARM) out on my home?

Here’s the answer.

It depends on what your objectives are.  The main question I ask to you is “how long do you plan on keeping the home”?

If you plan on keeping the home for a short period of time, then an adjustable rate mortgage may be a better or less expensive way to go.  Adjustable rate mortgage (ARM) interest rates are typically lower than a fixed rate mortgage rates, so the payment will be lower.  Also adjustable rate mortgages are amortized over 30 years.  So even though the mortgage rate may adjust, the mortgage payment and principal loan are still based on a 30 year period.

For example, if you know you’re going to be in your home for no more than 5 years, you may want to consider a 5/1 ARM, or 7/1 ARM.  These mortgage rates and payments are fixed for 5 yr or 7 years, so you will be protected while you own the home.

After the 5 or 7 years lapse, the mortgage rate will adjust and so will your payment – sometimes up and sometimes down.

If you’re not afraid of risk and you plan on keeping the home for a specific amount of time and you are confident you’ll be out of the home within that time period, then look at the adjustable rate mortgage that will protect you through that time period.

Look at the payment as well and compare that to a 30 yr fixed mortgage rate and payment.  See what the difference in payment and interest rate are.  Compare it to the adjustable rate mortgage ARM rate.  Are the lower mortgage rate and payment the adjustable rate mortgage is offering worth going into?

If you believe the savings is justified as the adjustable rate mortgage rates and payments will be typically lower than the 30 year fixed mortgage rates, then the adjustable rate mortgage is for you.  If not, stay with the conservative loan – the 30 yr fixed mortgage.  This way you know that your rate and payment won’t change  through the life of the loan.

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Mortgage rates are unchanged today despite a drop in prices yesterday

Rates on the 30 yr fixed mortgages are starting in the mid 4% range with buydowns. 

Rates on the 15 and 10 yr fixed mortgages are starting in the high 3% range with buydowns. 

Use the Amerisave rate calculator if you want to get a personalized rate quote.

Tomorrow we see retail sales and the University of Michigan consumer sentiment report.  Retail sales has the potential to move the bond market negatively if the number come in higher than expected. 

As of 12:57 PM ET, the DJIA, NASDQ and S & P 500 are all slightly down.

Yale Roth is a FHA Mortgage Specialist and provides mortgages for homeowners throughout the United States. 

For any specific mortgage-related questions, contact Yale at 561-350-7684 or email him at yroth@amerisave.com

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Watch this video:

In this FAQ, Yale Roth explains the difference between an adjustable rate mortgage (ARM) and fixed rate mortgage and which loan type may be better.  This video is very informative and lasts about 1.5 minutes.

Yale Roth is a Senior Mortgage Consultantand specializes in FHA Mortgages.  Contact Yale at 561-350-7684 with any mortgage-related questions.

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