Fixed vs Adjustable Rate Mortgages
2
Dolf Dunn Wealth Management, LLC Dolf Dunn, CPA/PFS,CFP®,CPWA®,CDFA Private Wealth Manager 11330 Vanstory Drive Suite 101 Huntersville, NC 28078 704-897-0482 [email protected] www.dolfdunn.com Fixed vs. Adjustable Rate Mortgages April 07, 2014 Like homes themselves, mortgages come in many sizes and types, and one of the most important decisions you face as you consider your choices is whether to take out a fixed or an adjustable rate mortgage. The type of mortgage that's right for you depends on many factors, such as your tolerance for risk and how long you expect to stay in your home. Fixed rate mortgages Fixed rate mortgages are very popular with homebuyers because loan payments are predictable. As the name implies, the interest rate on a conventional fixed rate mortgage remains the same throughout the term (length) of the loan. Your monthly payment (consisting of principal and interest) remains the same as well. The entire mortgage is repaid in equal monthly installments over the term of the loan (e.g., 15, 20, 30 years). The good news is, you're locked in; the bad news is, you're locked in Locking in a fixed interest rate on your mortgage has its good and bad points. If interest rates rise, yours won't; as a result, your monthly mortgage payment will always remain the same. This can be reassuring to homeowners on tight budgets or with fixed incomes. For this reason, fixed rate mortgages often appeal to individuals with a low tolerance for the risk associated with fluctuating monthly payments. But if interest rates go down, yours won't, and your (now high) mortgage payment will remain the same. While you might be able to refinance your home, paying off the higher-rate mortgage with one that carries a lower interest rate, this isn't always possible. In addition, the interest rate might need to drop significantly to offset the expenses associated with refinancing, and you'd need to remain in your home long enough to allow the monthly savings associated with the lower rate to recoup those expenses. One special type of fixed rate mortgage that may be available is an interest-only fixed rate mortgage. With this type of mortgage, the term of the loan is divided into two periods. During the first period (e.g., 10 years) you pay only interest and no principal so your payment is lower. During the second period (e.g., 20 years) you pay both principal and interest until the loan is paid off so your payment is higher. Because these mortgages carry certain risks, they're not right for everyone; you should be certain you can afford the higher payment you'll need to make during the second period before considering this type of fixed rate mortgage. Adjustable rate mortgages (ARMs) With an ARM, also called a variable rate mortgage, your interest rate is adjusted periodically, rising or falling to keep pace with changes in market interest rate fluctuations. Since the term of your mortgage remains constant, the amount necessary to pay off your loan by the end of the term changes as your loan's interest rate changes. Thus, your monthly payment amount is recalculated with each rate adjustment. Depending on what's specified in the mortgage contract, an ARM can be adjusted semi-annually, quarterly, or even monthly, but most are adjusted annually. The adjustments are made on the basis of a formula specified in the mortgage contract. To adjust the rate, the lender uses an index that reflects general interest rate trends, such as the one-year Treasury securities index, and adds to it a margin reflecting the lender's profit (or markup) on the money loaned to you. Thus, if the index is 3.13% and the markup is 2.25%, the ARM interest rate would be 5.38%. What's to keep the interest rate from going through the roof--or, for that matter, from plunging through the floor? Most ARMs specify interest rate caps. The periodic adjustment cap may limit the amount of rate change, up or down, allowed at any single adjustment period. A lifetime cap may indicate that the interest rate may not go any higher--or lower--than a specified percentage over--or under--the initial interest rate. Caution: Some ARMs cap the payment amount that you are required to make, but not the interest Page 1 of 2, see disclaimer on final page
-
Upload
dolf-dunn -
Category
Economy & Finance
-
view
41 -
download
2
description
So which mortgage is the right one for you? Wait for it…it depends! You know life is too complex for an easy rule of thumb. You should seek the advice of a qualified financial planner who does this kind of scenario all the time. The second thing you could do is give us a call..
Transcript of Fixed vs Adjustable Rate Mortgages
Dolf Dunn Wealth Management, LLCDolf Dunn, CPA/PFS,CFP®,CPWA®,CDFA
Private Wealth Manager11330 Vanstory Drive
Suite 101Huntersville, NC 28078
Fixed vs. Adjustable Rate Mortgages
April 07, 2014
Like homes themselves, mortgages come in manysizes and types, and one of the most importantdecisions you face as you consider your choices iswhether to take out a fixed or an adjustable ratemortgage. The type of mortgage that's right for youdepends on many factors, such as your tolerance forrisk and how long you expect to stay in your home.
Fixed rate mortgagesFixed rate mortgages are very popular withhomebuyers because loan payments are predictable.As the name implies, the interest rate on aconventional fixed rate mortgage remains the samethroughout the term (length) of the loan. Your monthlypayment (consisting of principal and interest) remainsthe same as well. The entire mortgage is repaid inequal monthly installments over the term of the loan(e.g., 15, 20, 30 years).
The good news is, you're locked in;the bad news is, you're locked inLocking in a fixed interest rate on your mortgage hasits good and bad points. If interest rates rise, yourswon't; as a result, your monthly mortgage paymentwill always remain the same. This can be reassuringto homeowners on tight budgets or with fixedincomes. For this reason, fixed rate mortgages oftenappeal to individuals with a low tolerance for the riskassociated with fluctuating monthly payments.
But if interest rates go down, yours won't, and your(now high) mortgage payment will remain the same.While you might be able to refinance your home,paying off the higher-rate mortgage with one thatcarries a lower interest rate, this isn't always possible.In addition, the interest rate might need to dropsignificantly to offset the expenses associated withrefinancing, and you'd need to remain in your homelong enough to allow the monthly savings associatedwith the lower rate to recoup those expenses.
One special type of fixed rate mortgage that may beavailable is an interest-only fixed rate mortgage. Withthis type of mortgage, the term of the loan is divided
into two periods. During the first period (e.g., 10years) you pay only interest and no principal so yourpayment is lower. During the second period (e.g., 20years) you pay both principal and interest until theloan is paid off so your payment is higher. Becausethese mortgages carry certain risks, they're not rightfor everyone; you should be certain you can afford thehigher payment you'll need to make during thesecond period before considering this type of fixedrate mortgage.
Adjustable rate mortgages (ARMs)With an ARM, also called a variable rate mortgage,your interest rate is adjusted periodically, rising orfalling to keep pace with changes in market interestrate fluctuations. Since the term of your mortgageremains constant, the amount necessary to pay offyour loan by the end of the term changes as yourloan's interest rate changes. Thus, your monthlypayment amount is recalculated with each rateadjustment.
Depending on what's specified in the mortgagecontract, an ARM can be adjusted semi-annually,quarterly, or even monthly, but most are adjustedannually. The adjustments are made on the basis of aformula specified in the mortgage contract. To adjustthe rate, the lender uses an index that reflects generalinterest rate trends, such as the one-year Treasurysecurities index, and adds to it a margin reflecting thelender's profit (or markup) on the money loaned toyou. Thus, if the index is 3.13% and the markup is2.25%, the ARM interest rate would be 5.38%.
What's to keep the interest rate from going throughthe roof--or, for that matter, from plunging through thefloor? Most ARMs specify interest rate caps. Theperiodic adjustment cap may limit the amount of ratechange, up or down, allowed at any single adjustmentperiod. A lifetime cap may indicate that the interestrate may not go any higher--or lower--than a specifiedpercentage over--or under--the initial interest rate.
Caution: Some ARMs cap the payment amount thatyou are required to make, but not the interest
Page 1 of 2, see disclaimer on final page
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2014
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for anyindividual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performancereferenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
The tax information provided is not intended to be a substitute for specific individualized tax planning advice. We suggest that you consult with aqualified tax advisor.
Securities offered through LPL Financial, Member FINRA/SIPC
adjustment. With these loans, it's important to notethat payment caps can result in negative amortizationduring periods of rising interest rates. If your monthlypayment would be less than the interest accrued thatmonth, the unpaid interest would be added to yourprincipal, and your outstanding balance wouldactually increase, even though you continued to makeyour required monthly payments.
The initial interest rates (referred to as teaser rates)on ARMs are generally lower than the rates on fixedrate mortgages. If you can tolerate uncertainty in yourmortgage interest rate and fluctuations in yourmonthly mortgage payment amount, believe thatinterest rates will stay low or go lower in the future, orplan to live in your home for only a short period oftime, then you may want to consider an ARM.
Hybrid ARMsHybrid ARMs are mortgage loans that offer a fixedinterest rate for a certain time period (3, 5, 7, or 10years), and then convert to a 1-year ARM. The initialfixed interest rate on a hybrid ARM is oftenconsiderably lower than the rate on either a 15-yearor 30-year fixed rate mortgage. The longer the initialfixed-rate term, however, the higher the interest ratefor that term will be. Generally speaking, even thelowest of these fixed rates is higher than the initial(teaser) rate of a conventional 1-year ARM.
Conventional fixed ratemortgage
Adjustable rate mortgage Hybrid adjustable rate mortgage
• Low risk• 10- to 40-year term• Interest rate doesn't change
during term• Payment remains the same
• Higher risk• Initial interest rate often lower
than fixed rate mortgage• Interest rate may go up or down• Interest rate usually adjusted
annually• Rate adjustments may be limited
by cap(s)• Payment caps can result in
negative amortization in periods ofrising interest rates
• Higher risk• Initial rate often lower than fixed
rate mortgage• Fixed term for 1 to 10 years, then
becomes a 1-year ARM• May have option to convert to a
fixed rate mortgage beforebecoming a 1-year ARM
• Interest rate may go up or down• Rate adjustments may be limited
by caps• Payment caps can result in
negative amortization in periods ofrising interest rates
Hybrid ARMs are ideal for individuals who plan to stayin their homes for a short period of time (3 to 10years), since they can take advantage of the lowinitial fixed interest rate without worrying about howthe loan will change when it converts to an ARM. Ifyou think your plans may change or you are planningon staying put for a while, look for a hybrid ARM witha conversion option. This option will allow you toconvert your loan to a fixed rate loan before it turnsinto an ARM.
Note: The Consumer Financial Protection Bureau'snew mortgage rules restrict certain interest-onlymortgage loans and loans that result in negativeamortization.
Page 2 of 2
