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LESSON 5: ARM vs. FRM
(continued from previous page)
All of these things should factor into
your decision between a fixed-rate mortgage and an adjustable one.
But there are other important questions to answer when deciding
which loan is better for you:
1. How long do you plan on staying in the home?
If you're only going to be living in the house
a few years, it would make sense to take the lower-rate ARM, especially
if you can get a reasonably priced 3/1 or 5/1 ARM. Your payment
and rate will be low and you can build up more savings for a bigger
home down the road. Plus, you'll never be exposed to huge rate adjustments
because you'll be moving out before the adjustable rate period begins.
2. How frequently does the ARM adjust, and when
is the adjustment made?
After the initial fixed period, most ARMs adjust
every year on the anniversary of the mortgage. The new rate is actually
set about 45 days before the anniversary, based on the index at
that time. But some adjust as frequently as every month. If that's
too much volatility for you, go with a FRM.
3. What's the interest rate environment like?
When rates are relatively high, ARMs make sense
because their lower initial rates allow borrowers to still reap
the benefits of homeownership. The chances are fairly good that
rates will fall down the road too, meaning borrowers will have a
decent chance of getting lower payments even if they don't refinance.
When rates are relatively low, however, FRMs make more sense. After
all, 7 percent is a great rate to borrow money at for 30 years!
4. Could you still afford your monthly payment
if interest rates rise significantly?
On a $100,000, 1-year adjustable-rate mortgage
with 2/6 caps, your 5.75 percent ARM could end up at 11.75 percent.
Here's what that means in dollars and cents:
|
Paying an ARM ... and
a leg
|
|
Year of ARM
|
Rate
|
Monthly payment
|
| First year |
5.75%
|
$584
|
| Second year |
7.75%
|
$716
|
| Third year |
9.75%
|
$859
|
| Fourth year (6% lifetime cap) |
11.75%
|
$1,009
|
Now, let's compare this worst-case ARM scenario to
a fixed-rate mortgage:
|
Fixed rate vs. ARMs
|
|
Mortgage Type
|
Interest rate for 4 years
|
Total payments
|
| ARM |
5.75% to 11.75%
|
$38,016
|
| Fixed |
7.75%
|
$34,368
|
|
With a fixed-rate mortgage, you save ...
|
$3,648
|
Now, plug
your numbers into the calculator to see which mortgage
would work better for you.
|
