You’ve found the perfect house. You’ve figured out exactly what you want to do with the kitchen, where the kids’ rooms are going to be and the placement of the living room furniture. But have you spent any time determining the best way to finance your new dream home? If you haven’t, you should. No, it’s not nearly as fun as mentally redecorating, but it is far more important and will have a lasting effect on how much money you have to spend on any future renovation.
The choice most homebuyers have is between a fixed or an adjustable rate mortgage (generally known as an ARM). The first, as the name implies is a mortgage with a fixed interest rate that remains constant throughout the repayment period of 15 or 30 years, the two most common terms. With interest rates still near all-time lows, this remains a popular choice, especially for people who have a stable, predictable income source, know they want to stay in their new location indefinitely, and can safely assume they won’t need or want to move in the coming years.
For home shoppers who desire an even lower initial interest rate, who may want to relocate in a few years, or who can safely assume their income will be on the rise, an ARM offers certain advantages. The initial interest rate on a 30-year ARM is usually lower than the rate you would be eligible for on a similar fixed mortgage, at least for the duration of the initial fixed term of anywhere from 1 to 10 years. Right now that difference on average, is about 0.6 percent lower, which can be a sizeable savings in your initial monthly payments. After the introductory period, the interest rate will be adjusted, usually annually, to a new rate based on some fixed standard, which almost invariably mean a higher monthly expense. A common standard used to set adjustable mortgages is the published rate for US Treasury Bills. Your new rate, for example, would be 2% – 3% above that. The amount that your interest can go up each year is usually limited by agreement to some small amount, often a cap of 2%, so you are protected against wild interest rate rises that you can’t afford. There is also an agreed-upon ceiling on the total amount the interest rate can be raised over the entire life of the ARM, so you have a predictable range of interest rates you might have to pay.
The Fed may raise interest rates again in the coming months, so anyone in a committed relationship with their new home will probably opt for a fixed rate. The more flexible can choose an ARM. If the Fed does raise rates it would mean their long-term payments could rise.
Senior Mortgage Lender
NMLS ID# 532621