Adjustable Rate Mortgage ARM vs. 30 Year Fixed Rate Loan?

"Always get a 30 year fixed rate loan!" or "Don't pay the higher interest rate on a loan that you will refinance later" or "You will sell that home when you need more space so why get a 30 year loan" - Have any of these advices been offered to you when considering which loan term to choose?

Those three suggestions are wise and unwise depending on your situation now and what you plan to do in the future. Can you predict the future? The answer is no and yet,  you can give probabilities to the future to help your decision.

First some facts:  The average home in the US is owned for approx 7-10 years. The average condo is owned for less than that. So - that may rule out the 30 year fixed rate loan immediately, A 30 year fixed rate loan today may have a 4.5% interest. A 7 year fixed rate loan today would be around 4%. So, if you are keeping the home for a shorter period of time, why pay approximately $500 extra per year for each $100,000 that you borrow? (I am sure somebody reading this is thinking what is $500 over 1 year - that is worth the comfort of a fully fixed rate loan)

Most shorter term fixed rate loans today are fixed for 3, 5, 7 or 10 years, amortized over 30 years and typically become annual adjustable rate loans after the fixed rate period.  There are different structures with other ARMs (adjustable rate mortgages) but this structure is very common.  The comfort of knowing exactly what your payment will be is either 3, 5, 7, 10 or 30 years depending on which fixed term you choose. The amount of interest rate that you pay rises typically from the shortest term to the longest term. It would be safe to say that you can get a mid 2% rate in the 3 year range and a 4.5% rate in the 30 year range. That difference may be significant depending on  your current and future plans for the property.

Let's say you are buying a small starter home with plans to want a larger home in 3 years. If you plan to sell the home in 3 years, then a 3 or 5 year fixed rate loan may be perfect. But... what if you decide to buy a larger home in a few years as planned and keep this first home as a rental property? Now, you have a loan which will start adjusting every year (or monthly) which fluctuates your cash flow.Future hindsight may tell you that a 7 or 10 year fixed rate would be better. It's sad that we cannot rely on future hindsight now!

Now take my mom as an example (sorry Mom!). She is retiring in the next few years. A 30 year fixed rate loan may be the best choice for her. Refinancing or dealing with an adjustable rate payment when going into retirement (fixed income) is not ideal. Solid, secure financing makes sense then.

Where are you in this spectrum of home ownership? Let's talk and flush out the best plan for you. Mario cell: 415-269-6249 call or text

Or see my site:  www.HomeLoans.LA

To Pay a Point or Not to Pay a Point?

Should a home loan borrower pay an additional point - think 1% of the loan amount - to lower the rate of the loan over its amortization period? The answer is: maybe....

The answer is in the arithmetic and what you think of the future.

First - if you pay an additional point - how much will the loan interest rate and the loan payment decrease of the life of the loan?  And what is the recoup time to cover the point?  If your loan payment goes down by $50 per month on a $100,000 loan and it costs you $1,000 to get this reduction - then the recoup time is 20 months.  So, on a strictly numerical basis, if you keep the loan for more than 20 months, then the payment of the $1,000 is well worth it.  If you happen to sell the home or refinance the loan before 20 months, then you have not achieved a full benefit of paying the point.

Second - What is interest rates move lower and you want to refinance to get a better rate.  Your break even point is now $1,000 further away.  This is neither good nor bad - just an issue of checking the arithmetic again.

And finally - who ever holds their loan for 30 years??? OK - that was a separate issue, but one that should be considered when thinking Rate, Term and Points.

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