Home buyers are pretty terrible when it comes to choosing the best mortgage loan to fit their life, data shows.
90% of today’s mortgage loans are of the 30-year, fixed-rate variety. Yet, most homeowners change residences within eight years, which means that an adjustable-rate mortgage (ARM) may be more appropriate.
When you use an ARM for your house instead of a fixed-rate loan. your interest rate starts lower, your monthly payments due are smaller, and your loan terms can be customized to meet your specific budgetary needs.
So, why don’t more home buyers use ARMs when ARMs are clearly a better choice? We asked. Buyers tell us it’s because ARMs are unfamiliar.
It’s human nature to be cautious about things we don’t understand.
The good news is that ARMs aren’t all that complicated, so here are five things you need to know about adjustable-rate mortgages and how they work:
- Your ARM has a starting interest rate, called a “teaser”
- You can choose how many years this teaser’s in effect — usually, people choose 5 years or 7 years
- When the teaser period ends, your interests rate adjusts once per year
- Your ARM’s adjusted interest rate adjustment is determined by a pre-determined formula
- The formula has yearly caps, so the rate can’t spike from year-to-year
When would you use an ARM? Here’s a real-world example.
Let’s say that you’re buying a house and you know it won’t be your forever home; you’ll be moving within five or six years.
So, you go with a 5-year ARM.
For the first 5 years of the loan, your interest rate is, say, 4.25 percent. Then, that fifth year ends. You get a letter from your lender. It says your loan will adjust to a new interest rate.
Your new interest rate, based on market conditions, is calculated to be near nine percent, but because your loan is capped at movements of two percentage points per year, your rate adjusts to 6.25 percent.
Then, a few months later, in the middle of your sixth year in the house, you list your house for sale and move out — as you planned originally. Assuming your starting loan size was $200,000, you’ve saved close to $5,000 overall by choosing an ARM instead of a 30-year fixed-rate mortgage.
Are you a first time home buyer?
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When your lender says, “you have to act quickly” is not some high-pressure sales tactic meant to make you feel fear. It’s the truth.