Mortgage Planning: Fixed or adjustable?
For a Charlotte homebuyer, once you have determined the down payment size, the next most critical piece of a mortgage plan is to decide which loan program is best for you. Over the past year, most Charlotte homebuyers simply chose a 30-year fixed-rate mortgage. As recently as 2010, Freddie Mac reported that over 95% of homeowners who refinanced chose a fixed-rate mortgage.
Certainly, there is nothing wrong with a fixed-rate mortgage – it’s just that for some people, they can save a lot more money by strategically choosing an adjustable-rate mortgage or ARM. However, not all ARMs are the same.
In the sub-prime days of 2003 to 2007, many homeowners got in trouble with ARMs, but these were not the same ARMs that are offered today. The sub-prime ARMs adjusted after just two years, and they had a very high margin, so that rates could jump by 5-8% on the mortgage. These loans also carried a pre-payment penalty – so a homeowner was stuck with either a higher interest rate for the third years, or, they would have to pay a pre-payment penalty to get out of their ARM.
Sub-prime ARMs were rarely a sound part of a mortgage plan and, in fact, were often pushed on homebuyers by greedy lenders. Homebuyers were usually overly optimistic as well, so they can shoulder some of the blame for buying something when they didn’t know all of the risks. However, the good news is that sub-prime 2-year ARMs no longer exist, so they aren’t a threat to a Charlotte homebuyer.
Today’s ARMs are much different and pretty safe for some Charlotte homebuyers. They usually will have a fixed-rate period for the first 5 or 7 years, and then will adjust after that. The trick to these loans is to only use them if:
- You are going to save too much money to pass them up
- You are pretty sure you will only use the money for 5-7 years
- You have a plan to pay off the loan in 5-7 years.
Saving too much money to pass up an ARM?
As part of a mortgage plan, a homebuyer could choose a 7/1 ARM and then apply the monthly savings to paying off the loan faster. For homebuyers making a less than 20% down payment and paying PMI, a 7/1 ARM can be a great loan strategy for a disciplined homebuyer to use to build equity faster – as long as the monthly savings are used to pay down the loan faster to get rid of PMI. If you are only going to own your Charlotte home for 5-7 years or less, the lower rate on the ARMs could make sense for you, as well. For some people, the plan is to carry a mortgage for 5-7 years and then pay off the loan. If this is your idea, it makes sense to look at an ARM and see if the total cost you pay on an ARM is low enough to forego a more traditional 30-year fixed-rate mortgage.