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Looking To Finance The Purchase Of Your New Home
If you are looking to finance the purchase of your new home, one choice that you face is whether to apply for a fixed rate for the entire term of the note or an adjustable rate mortgage (ARM). While a fixed-rate note is a good idea when rates are low, if you think that rates are high and will go down over the next few years, then an ARM makes sense. Also, if you think you won't need the mortgage past five or ten years, then an ARM also makes sense, because it is generally available to start out at a lower rate than what you can get a fixed-rate note for, because the sellers of the note realize that you are taking a risk and are willing to reward that now. In the summer of 2013, for example, Facebook CEO Mark Zuckerberg used an ARM with an interest rate of only 1.05 percent to finance his home. While you don't likely have the financials to score that sort of rate, an ARM can make sense for a variety of new homeowners.
Let's take a look at a 5/1 ARM that starts you out at 3 percent, with a 5 percent cap change after the end of that fifth year, meaning you go to as high as 8 percent at year six. We'll compare it with a 30-year note at 4 percent, which is a valid comparison in the current market for borrowers with superior credit scores. Assuming the very worst, which is an that the rate goes up to 8 percent when the 5-year period ends, here's now the numbers work. For years one through five, the monthly payments on an $800,000 loan work out. The monthly payments on the ARM work out to $3,373. On that fixed-rate note, just a point higher, those payments would be $3,819. Over those first five years, the ARM gives you $12,000 more in equity and saves you $39,000 in interest. Now, after those five years, if the ARM swelled up to 8 percent, that monthly payment would swell up to $5,490. However, you wouldn't lose the full advantage of the ARM until year seven. However, if that ARM failed to jump to the worst case scenario but instead jumped to 5 or 6 percent, then you wouldn't hit that break-even point until year 10. This fails to take into account the tax deduction for mortgage interest, which would be somewhat higher for the fixed-rate note for the first several years but would be greater for the ARM afterward.
So what's the bottom line? The question really centers around how long you plan to stay in the house. If this is the house in which you plan to raise your family and see your grandchildren come over to visit you, then that fixed-rate note might be the better idea. If you're not sure, or if you know that you want to retire somewhere else once your kids head off to college, then the ARM might be the better choice. Another scenario involves borrowers who get a loan even though their credit is fairly poor. Your offers for a fixed-rate mortgage loan might well include interest rates that are well above prime because of your unattractive credit history. However, in a few years, you might have some of those unsightly items come off your credit report, or if you make several years of payments in a reliable fashion, and you don't add any more negative items to your report, you are likely to find a lender who will give you a refinance at a lower fixed rate than what you can get now. It might make a lot of sense to get that ARM now at a lower rate and make some accelerated payments to bring down your principal. Then, before the five years have elapsed, you would go back and request that refinancing from another lender. Using your new information, with the new rate, you would still end up saving money over time.
Purchasing a house likely represents your largest financial decision. Choosing the right plan for your mortgage is therefore one of the most important financial decisions that you can make. Use the information in this article to determine whether a fixed-rate note or an ARM is the best vehicle for you. Over time, the interest you pay on a mortgage is a huge amount of money, so this has a significant impact on your nest egg down the road.
ABOUT THE AUTHOR
Douglas Lenski is a 14 year veteran of the mortgage industry and the current President of Wholesale Mortgage Services of Wisconsin. He has trained 20 loan officers and 8 mortgage loan processors. He is considered an expert in the mortgage industry by his peers. He has written many blogs on mortgage rates today , Wisconsin Mortgage rates and many more.
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