Rates on an Adjustable Rate Mortgage (ARM) can look appealing because they start off typically lower than a fixed rate mortgage; however, you need to look at the big picture before making a decision. A five year ARM will only give you the benefits of the lower rate for the first five years and then it will begin adjusting, possibly even annually, after that. What looked like a good option at the start could end up costing you thousands if you stay in your house for the long term. You have no way of knowing what rates will look like in five or ten years.
Do the Math
If you want to see which option is your best bet, do the math. Run the numbers of a standard 30 year fixed-rate mortgage and an ARM to see how they compare in the long term.
For example take a look at what your monthly payments would be if you obtain a $200,000 mortgage with 20% down:
- 30 year fixed at 3.259% = $964
- 5 Year ARM at 3.108% = $951
While the lower payment and rate might want to make you sign on the dotted line, you have to remember that after the first 5 years your rate on the ARM is going to increase, along with your monthly payment. It could increase every year after, making the 30 year fixed rate a better deal over the life of the loan.
Compare Fixed Rate Mortgage Options
When thinking about fixed rate mortgage most people think of the standard 30-year mortgage. However, another option exists in the form of a 15-year fixed-rate mortgage. If you compare the same numbers from above, your monthly payment would look like this:
- 15 year fixed at 2.938% = $1,367
This option provides you with the lowest rate, but your payment is $403 more than a 30 year mortgage. If you can afford the extra amount required to do a 15-year mortgage you pay your mortgage off 15 years earlier. This results in paying much less in interest and having the opportunity to actually own the deed to your home after 15 years.
If you like the idea of paying your mortgage off faster and paying less interest, but can’t afford the full commitment of a 15-year fixed mortgage payment, there is still an option for you. Go with the standard 30-year mortgage, but pay whatever extra you can on the principal each month. Even paying an extra $100 over your standard monthly payment will result in a savings on interest and paying your loan off faster.
If you are looking to own your own home for only a few years before selling and moving on, an ARM might be a great fit for you. If you are looking to purchase for the long haul, go with a fixed rate. Whichever route you choose, make sure you obtain a mortgage that you can comfortably make payments on each month.