FIXED
vs. ADJUSTABLE RATE
One of the most common questions a
Certified Loan Broker answers is, "should I choose a fixed or
adjustable rate mortgage (ARM)?"
The answer depends on many different factors including your
income at the time of qualifying, the lender you are working with,
current market conditions and how long you plan to stay in the house.
Lets talk about your income first.
Many first time buyers who are in the beginning stages of their
careers will choose an adjustable rate over a fixed rate.
The main reason is that, while the interest rate on the
adjustable will likely increase over the coming years, the borrowers
level of income can outpace the increased monthly payments.
For this reason, adjustable rates tend to be the loan of
preference for new college graduates who are beginning work in the
field they studied. On
the opposite end of the spectrum are high-income borrowers and real
estate investors. These
people tend to prefer adjustable rates because of the opportunity to
make reduced monthly payments. High-income
borrowers will then either invest the difference between the fixed
rate and ARM payments, or use the starting period when the rate is
very low to apply large amounts of money to the principle balance.
This will enable them to pay off the loan faster and minimize
future payment increases since they will be financing less money.
Because of the lower initial interest rate,
adjustable rates result in a lower mortgage payment than the standard
fixed-rate mortgage. This
lower monthly mortgage payment can assist a borrower with high debt
ratios in qualifying for a larger mortgage.
This allows a borrower to increase their purchasing power in
order to buy a more expensive home.
If your income is not an issue, the next
thing to consider is the lender that you choose for your loan. Some
lenders actually prefer to write adjustable rate loans because, over
the long run, it will provide them with more interest income.
Because there is an additional profit in the loan, ARM lenders
may make it easier for you to qualify.
This is where your Certified Loan Broker can be particularly
helpful. Because
Certified Loan Brokers work closely with many lenders, they know which
lenders prefer to do fixed or adjustable rate loans and can steer
your loan in the proper direction.
Another issue to consider is the current
real estate market conditions. When
interest rates are down, many lenders are apprehensive to offer ARMs
because it is more difficult to find investors.
The opposite is also true when interest rates are higher. This is also an area where a Certified Loan Broker can be particularly helpful since they are actively
engaged
in the real estate market and know the current trends.
The last issue to consider
in deciding
between fixed and adjustable rates is how long you intend to occupy
the property. As a
general rule of thumb, most people will be better off with a fixed rate
if they plan to be in the property for more than five years.
At that point, your interest rate for an ARM will usually have
increased substantially so your payment will be much higher than if
you had taken a fixed rate. On
the other hand, if you are planning to stay less than 5 years, then
the thought of buying 30-year money is probably not very appealing.
Also, as we have already discussed, if you put extra money to
principle when your interest rate is low it will help to keep large
payment fluctuations in check. You
should also consider that adjustable rate mortgages have built in
safety measures known as "caps" that will help limit how
high your interest rates can rise per year.
Most adjustable rates are structured so that the annual
interest rate cannot rise by more than 2 percent per year, although
some loans have caps that are even more conservative. Other loans will not regulate the interest rate at
all but instead limit how high the payment can rise each year.
You should consult with a Certified Loan Broker to help you
determine if a fixed or adjustable rate loan is right for you.