Now we’re at the stage of comparing apples with oranges. However, in truth, a direct one-to-one comparison isn’t usually very helpful. Rather, what’s more important to most borrowers is comparing the usefulness of each type. It’s sort of like saying, “Do I want to eat an orange now, or will an apple taste better?” Here are some guidelines that may prove helpful.
When interest rates are low, get a fixed-rate mortgage to lock in the low rate. When interest rates are high, consider an adjustable-rate mortgage with payments that will fall as interest rates come down.
If you desperately want to buy a home but can’t qualify for a fixed-rate mortgage, try an adjustable. The lower teaser rate should make qualifying a bit easier. (Currently lenders qualify not just on the basis of the teaser, but on an average between the market rate and the teaser, which is still probably lower than for a comparable fixed-rate mortgage.)
If you can’t afford to have fluctuations in your monthly payment, get a fixed-rate mortgage. You’ll at least know what your payments will be every month.
If you plan to sell soon, get an ARM and take advantage of the low teaser rate. But beware, your plans could change unexpectedly!
Sometimes ARMs have lower initial loan costs. If cash is a big consideration for you, look into them. Remember that with an ARM, if interest rates go up, so do your payments. (This may occur even after rates have peaked and started to come down. Because of your adjustment period, you may play “catch-up” for months after the downturn.) You can’t call your lender later and say, “I can’t handle a $200 increase in my monthly payment!” Your lender isn’t going to be sympathetic and will threaten you with foreclosure if you don’t pay. The time to consider a big monthly increase is before you get that adjustable-rate mortgage, not afterward.
Fixed- or Variable-Rate Mortgage?
You should get a fixed-rate mortgage:
■ If you can lock in a low-interest rate
■ If you plan on keeping the property a long time
■ If you want a fixed mortgage payment (does not go up or down)
You should get a variable rate mortgage:
■ If interest rates are high and you can get a long-term, low initial (teaser) rate
■ If you plan on selling or refinancing soon
■ If you can handle flexible mortgage payments (that can rise during the life of the loan)
Hybrids: What About a Combination Fixed and Adjustable?
There are a whole bunch of hybrids out there, any one of which may be better for your situation than a straight fixed or ARM mortgage.
What Is a Convertible Mortgage?
Some ARMs may be “convertible” to a fixed rate, or vice versa. Many allow a conversion at a set date—three or seven years, for example— in the future. Just be sure the conversion is guaranteed at the lowest interest rate at the time of conversion.
There are literally hundreds of types of convertible mortgages available. Some lenders will even create one just to suit your financial situation. Be sure to ask.
What About Short-Term Fixed, Amortized over 30 Years?
The whole point behind an ARM, from a lender’s perspective, is to give a loan that can respond to interest rate fluctuations. Another way of accomplishing this is to give a shorter-term fixed-rate mortgage.
Currently lenders are offering short-term fixed-rate mortgages in the following time lengths, all amortized over 30 years, 15 years, 10 years, 7 years, 5 years, or 3 years. The shorter the term, the better the interest rate is. What this means is that after the initial period, you have a “balloon,” a single large payment where the remaining balance is due.
For example, you can get an interest rate reduction if you agree to get a loan with a balloon in 15 years (see the following). You might get an even bigger reduction if you agree to a balloon in 10 years instead of 15. If you agree to a balloon in 3, you might get the interest rate reduced the most. (Note: The monthly payments can still be spread out—amortized—on the basis of 30 years. It’s just that you have a shorter due date, or balloon payment at the end.)
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