 Adjustable-rate
or fixed-rate mortgage?
|  Dear
Dr. Don,
Should my newly married daughter get an adjustable-rate mortgage
or fixed-rate mortgage if she only plans to stay in their newly purchased home
for five years?
-- Janis Juried
 Dear
Janis,
I'd recommend a hybrid adjustable-rate mortgage, or ARM, that matches
the time she expects to be in the home. A 5/1 ARM would do
the trick. There's not a lot of difference between a 30-year
fixed-rate mortgage and a 5/1 ARM, so if she's not sure how long
she'll be in the house, the 30-year fixed rate is a pretty inexpensive
way of protecting against a big rate adjustment five years from
now, if she's still in the house.
Weekly
national mortgage survey
Here are the results of Bankrate.com's Feb. 21,
2007, weekly
national survey of large lenders and the effect on monthly payments for a
$165,000 loan:
 |
Mortgage survey |
|
| This week's rate: | 6.29% | 6.15% |
| Change from last week: | -0.03 | -0.03 |
| Monthly payment: | $1,020.46 | $1,005.23 |
What's relevant for comparison for your daughter is
the fixed rate or 5/1 ARM rate that she and her husband qualify
for, not some national average. Regardless it's this type of analysis
that allows them to decide the type of mortgage that's right for
them. Bankrate has an interactive
work sheet
that can help the couple decide on fixed- versus variable-rate financing.
The national average for a one-year ARM was 6.03 percent
on Feb. 21, 2007. That would result in a payment of $992.44 for
a $165,000 mortgage, or about $13 less per month than the 5/1 ARM,
and $28 less per month than the 30-year fixed rate loan shown in
the table above. Saving $13 per month isn't inconsequential but
neither is taking on four years (or more) of interest-rate risk.
Where people often go wrong in choosing the ARM is
they assume they can refinance to a fixed-rate mortgage if rates
start to move against them. While that's sometimes true, the cost
of refinancing and the potential for a higher interest rate on the
new mortgage versus what they could get today on a 5/1 ARM or a
30-year fixed-rate mortgage can make it an expensive fix. Saving
$13 per month for five years provides $780 in savings. The Bankrate's
2006 closing
cost survey
showed the national closing cost average on a new first mortgage
is $3,024.
We
don't know what will happen to short-term interest rates over the next five years.
Lower rates will result in lower mortgage payments when the ARM resets. My assessment
is that there's more risk on the upside (higher rates) than there is opportunity
on the downside for lower rates. That's why I don't like the ARM. But if
your daughter is willing to accept the risk, and she's pretty sure she's not in
the house for the long term, it's a manageable risk to take.
To ask a question of Dr. Don, go to the "Ask
the Experts" page, and select one of these topics: "financing
a home," "saving & investing" or "money."
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