The type of loan you decide to take out on your home can be tailored to meet your financial goals. One of the factors that you should think about before talking to lenders is how long you will live in your home. If you plan on selling within a few years, an adjustable rate mortgage might save you money.
Adjustable rate loans usually have an initial period where the introductory rate is fixed. The shorter this period, generally, the lower the rate and the margin. The margin is the amount that’s added to the index to arrive at the rate you pay.
How much can you save by taking out a short term ARM? Lets use an example of an $165,000 loan. If you took out a 30 year 6.25% fixed rate loan your monthly payment would be $1,015.64. At the end of three years you would have paid at total of $36,540. Your loan would have a balance of $158,818 so you would have paid over $30,350 in interest.
Lets say that the introductory rate for the 3 year ARM is 5%. If you took out a loan of $165,000 your monthly payment for the first three years would be $885.76, at the end of three years you would have paid a total of $31,887.36. The balance on your loan would be $157,316.70. You would have paid out $24,203 in interest.
So your total savings in interest would be $6,147 but that isn’t all you’ve gained. Because you had the lower rate, you’ve paid off more of the loan so you have an additional $1,500 in equity in your home. So the total saving is over $7,600.
But the savings is based on the idea that after 3 years, you’ll sell your home. If you decide to stay and the interest rates go up, you could wipe out all those gains in a few years.
Over the last few years, interest rates have been very low. It is very likely that the rates will go up in the next few years. Any adjustable rate loan will probably cost more as the years go by.
At the end of the 3 year period you could, of course, refinance at a fixed interest and lock in those gains. But every time you refinance, it costs a certain amount. There are always fees associated with the process. Also, if the rate on the ARM has gone up, that means that fixed rates have gone up also. Whatever you saved in the initial period could be overshadowed by what you pay over the long haul.
Take some time to think about your financial goals before you sign up for a mortgage. It’s a big decision and one you’ll have to live with for a long time.
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