ARM vs. Fixed?
Let’s say you’re at an amusement park. One with lots of rides. And each ride is like a different mortgage — some are safe and predictable (like the Merry Go Round), and others are more exciting (like a roller coaster). And some are downright terrifying, like the one where you’re strapped into a cage that spins around upside down in the dark and everyone throws up.
But back to your mortgage. What kind of ride do you want? If you’re like many people, you want something stable and safe, like a 30 year fixed. A 30 year fixed is like a ride on a Merry Go Round, but instead of your horse rising up and down, your horse is nailed to the floor.
You like the idea of the roller coaster — everyone seems to be having a good time — but you’re worried. The bar might be loose and you’ll fly out or the whole car will get stuck hanging upside down and everyone will be sending photos to their friends but your phone runs out of juice so when you finally get down, no one believes you.
The roller coaster is like an ARM. You can save money (that’s exciting!) but you also have some risk. With the Merry Go Round (30 year fixed), you have no thrills but no risk. Your rate will be higher on a fixed than on an ARM, but you have no interest rate risk.
Let’s look at some numbers: If you took a 30 year fixed at 4.25% with zero points and borrowed $417,000, your monthly principal and interest would be $2,051.39. And that payment would stay exactly the same for the full 30 years.
Now let’s look at a 5 Year ARM, which is available at 2.75% with zero points. With this loan, if you borrowed $417,000, you would pay $1,702.36 per month. And those payments would stay exactly the same for 5 years (for more information on ARMs, see “How ARMs Work”). So over 5 years, you would save $349.02 per month, or $20,941.46 over 5 years. That’s a lot of money. Is it worth it to you to save almost $21K? It depends. Depends on: where you think rates are going to be 5 years from now; where you think your household income will be 5 years from now; where you think you’ll be 5 years from now.
If you were a doctor doing his residency and the next few years would be very lean but you know you’d be making more money later, you might want to save $21K now because you know, no matter where rates are 5 years from now, you’ll be making so much money you can refinance into a fixed at that time. Or you might have one wage earner staying home with a baby, but 5 years from now, they’ll be in school so that person can go back to work. Or you might have a job where you’re pretty sure you’ll be relocated in the next 5 years, so you only need this loan for a short time period.
Let’s say you to take a 30 year fixed. 5 years later, you have to relocate for your job, so you sell your house (and pay off your mortgage). You have now paid $21k more than you had to if you took an ARM.
So there are situations where a 30 year fixed could end up costing you more than an ARM.
Bottom line – you owe it to yourself to at least ask what the rate and payment is on an ARM; evaluate the difference; decide if it’s a meaningful difference to you, then choose the right program for your needs.
INSIDER’S TIP: There is no one loan that is right for everyone, at every time of their life. You need to compare payments between a fixed and an ARM, take into account your financial and employment situation, and decide if the savings is worth the potential interest rate risk.
(c) Copyright Eris Saari 2016