Rock-Bottom Rates Force Some Retinking on Fixed -vs- Adjustable Mortgage Loans.
By Dave Eshleman - Owner Broker
The decision to select a fixed-rate mortgage over an adjustable one has often been an emotional one – it’s very difficult to know which will be lowest over the long term, so many borrowers, fearing a worst-case scenario, choose the safe bet.
But recent rock-bottom 5/1 adjustable rate mortgages of 2.5% may deserve another look by those who swear by fixed rates. The numbers are hard to dispute.
As an example, Let’s say JOE took out a $500,000 loan at the current fixed rate of 4.75% with a payment of $2,608.23 per month. Over five years, that’s $156,494.20.
But his sister JILL took out a $500,000 mortgage at 2.5% with a payment of $1,975.60 month, a total of $118,536.27. So over five years Jill spent $37,957.93 less than Joe.
But it gets even better. A lower interest rate reduces the loan’s principal balance FASTER than a higher rate. So, after 5 years, the $500,000 balance on Jill’s 5/1 ARM would be $17,114.28 LOWER than the balance on Joe’s 4.75% fixed rate. Add that to the $37,957.93 Jill saved on the payments, and she’s $55,072.21 ahead of Joe after five years.
“Aha!” you say. “But what happens to poor Jill when her rate starts changing after five years?” Nobody knows FOR SURE what will happen after 5 years, because the rate at that time depends on what happens to the 1-year LIBOR index, on which the loan’s future adjustments will be based. But what if we take a WORST-CASE scenario?
The highest rate possible under the 5/1 plan is 7.5%, or 5 points over the start rate. So, if Jill’s balance at the start of year 6 is $440,376.91, and the rate is 7.5%, her payment will jump to $3,254.35 per month. Now Joe is looking good, right?
But wait! Remember that Jill started the 6th year $55,000 ahead of Joe. She’s now paying $646.12 more per month than JOE, but at that rate it will take another 5 years before she loses her advantage. And that’s WORST-CASE!
So the key question is: How long do you expect to own your home? Of course, most people, when they purchase a home, don’t really know, but if you’re like most, the answer is: about seven years.
And because we are independent, we work for you! Not the bank. Think about that next time you need a home loan.
Call us at: 408.872.8100 or email me at:
davee@finetsaratoga.com
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