Fixed Rates: Your Pot of Gold at the End of the Rainbow
It’s no secret that all of us at RMN are passionate about offering fixed rate financing for our borrowers. However, it’s important for you to understand exactly WHY we are such proponents of fixed rates.
After all, “What’s the harm if I get an adjustable rate mortgage (ARM) from my local bank? It has the lowest rate of all the mortgage options I was offered, and my plan is to move out and sell the house before the rate adjusts in 5 years. Even if not, my bank tells me an ARM is a great option for people like me who expect their income to increase in the next 5-10 years. So I’m good right?”
Well, this is a great sales pitch, but getting into an ARM is a significant risk – one you simply shouldn’t take if you qualify for a fixed rate mortgage.
Before we get into the benefits of choosing a fixed rate product, let’s take a step back and look at the presence of ARMs in the marketplace throughout the entire country. A recent study by the Mortgage Bankers Association found that ARMs accounted for only 6.7% of all mortgage originations in the United States. Wow, only 6.7%? That seems telling. The truth is that an ARM creates significant risk exposure for a borrower, and in our current economy, should only be used out of necessity. Clearly the rest of the country is well aware of adjustable rate risk, but for some reason, there’s a glaring lack of education in our market here in Iowa.
“Ok, so why exactly is a fixed rate mortgage a less risky option?” Take a look at the graphic below. This illustration shows an example of the consequences of a borrower who was deciding between a fixed rate loan v. an ARM 5 years ago in 2013. During this time, rates were at their all-time low, and it was common for a home buyer borrowing $265,000 to be offered an ARM with an initial rate of 3.000% v. a fixed rate product at 3.125%. All else equal, the only difference between the two loan products is the amount of interest paid each month by the borrower.
In the graph, you’ll see that the adjustable rate mortgage resulted in savings of $27/month on average during the first 5 years of the loan. However, on the right you’ll see the updated payment comparison in 2018 after the ARM adjusted to today’s interest rate. The ARM borrower is now paying $319/month more than the fixed rate borrower PURELY IN INTEREST! $319. EVERY MONTH. For the ARM borrower, it will only take 5 months for the new ARM payments to wipe out every penny of savings provided by the ARM during the initial 5 year period. It’s also important to remember that most ARMs reset every year, so the $319/month payment difference may very well continue to increase year after year. Your bank telling you that an ARM is fine because your income will increase is essentially their way of saying, “who cares that you’ll be throwing money away in 5 years — at least you’ll probably be able to afford it.” I don’t know about you, but I can think of several things I’d rather do with my money than pay extra mortgage interest for no reason.
Why Choose A Fixed Rate?
Despite recent increases, interest rates remain at a historically low figure. More importantly, virtually all economic projections anticipate continued rate increases in the future. “Okay, but what does that mean for me?” Well, pretty much every expert in the world is betting that if you get an ARM now, you will end up paying hundreds and hundreds of dollars in additional interest per month when the teaser rate expires in 5 years. It just doesn’t make any sense to take this risk when the reward is only a few bucks per month.
“But an ARM rate adjustment won’t affect me, as I plan to sell my new house within the next 5 years.” Life is uncertain. Things happen and plans can change in an instant. What if you decide you want to move into a new house in 5 years, but you’d also like to keep your current home and rent it out? Wouldn’t it be nice if you could continue to finance the home with a low interest rate that is locked in for another 25 years? Secondly, if rates actually do increase as much as many expect, you might not be so excited about buying a new house and paying interest that’s 1, 2, or maybe 3 percentage points greater than your current home loan. You might wish your current interest rate was fixed so you could simply stay in your present house and continue taking advantage of the great low interest rate.
The future is always uncertain, but a fixed rate truly is your pot of gold at the end of the rainbow. Contact Residential Mortgage Network to explore all our great loan options today!