Mortgage Rates Are Higher. Is an adjustable rate mortgage a better fit?

This depends on a few factors:

  • risk appetite- comfortable are you knowing that interest rates down the road will be different, put another way, how comfortable  are you with the unknown?
  • loan hold time- selling the  house or refinancing again in the next 5 to 7 years? If you know this than an adjustable-rate mortgage could be a viable option
  • cost- depends on the situation, but generally any costs should be minimized is much as possible on a shorter-term debt structure so as to keep the recapture in line with future expectations with paying off the lien

In short, adjustable-rate mortgages are based on a 30 year amortization in most cases i.e. 360 months. The first initial term such as the first 60 months or 84 months representing a five-year or seven year arm is fixed. After the first five or seven years, the loan for the remainder of the duration of the loan, 25 years or 23 years is amortized based on a 30 year term. The interest rate is then computed by simply adding the index the adjustable-rate mortgage is tied to such as the LIBOR, plus a margin the lender sets typically somewhere around 2.25%. Presently, the 12 month LIBOR is .698%, adding the margin would provide a the fully indexed interest rate of 2.95%. Not a bad interest rate considering 30 year fixed rate mortgages are upwards of 4.875%.

*What  to remember, the average 30 year mortgage rate is 6% and has been such ever since the 1970s, when mortgage interest rates began being recorded. 

The only time in the last 43 years when interest rates were above 6% was during the late 1970s through early 1980s as a result of a combination of three factors; the Cold War, the Oil Embargo, and massive runaway inflation. The Federal Reserve has sharpened their pencil substantially since then, preventing runaway unabated inflation. Simply put, taking out an adjustable-rate mortgage and being into the first adjustment after the five or seven years for example, you can expect your mortgage rate to be somewhere around 6% give or take.

According to Fannie Mae, the typical homeowner refinances every 5 to 7 years anyway due to life events and interest rate fluctuation, so the likelihood of taking out a 30 year fixed rate mortgage and actually keeping that loan for 360 months, big scale, is relatively small.

If you’re looking for a lower cost mortgage, an adjustable-rate mortgage perhaps with the longer term seven years or 10 years might be a nice fit depending on your financial goals. Start today by getting a complementary rate quote for your purchase or refinance.

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