At Telco Credit Union, we know how important it is to save money and consider your financial future. One such way is to teach your children how to be financially smart and to set them up as best as you can. Telco serves the Eastern North Carolina area, including Greenville, Tarboro, and Rocky Mount. You can trust Telco with all your financial needs, whether you’re looking to open a checking or savings account, take out a loan, finance your mortgage, or become a Telco member/owner.
When choosing a mortgage, you need to consider a wide range of personal factors and balance them with the economic realities of an ever-changing marketplace. Individuals’ personal finances often experience periods of advance and decline, interest rates rise and fall, and the strength of the economy waxes and wanes. To put your loan selection into the context of these factors, consider the following questions:
- How large a mortgage payment can you afford today?
- Could you still afford an ARM if interest rates rise?
- How long do you intend to live on the property?
- In what direction are interest rates heading, and do you anticipate that trend to continue?
If you are considering an ARM, you should run the numbers to determine the worst-case scenario. If you can still afford it if the mortgage resets to the maximum cap in the future, an ARM will save you money every month. Ideally, you should use the savings compared to a fixed-rate mortgage to make extra principal payments each month, so that the total loan is smaller when the reset occurs, further lowering costs.10
If interest rates are high and expected to fall, an ARM will ensure that you get to take advantage of the drop, as you’re not locked into a particular rate. If interest rates are climbing or a steady, predictable payment is important to you, a fixed-rate mortgage may be the way to go.
Candidates for ARMs
The Short-Term Homeowner
An ARM may be an excellent choice if low payments in the near term are your primary requirement, or if you don’t plan to live in the property long enough for the rates to rise. As mentioned earlier, the fixed-rate period of an ARM varies, typically from one year to seven years, which is why an ARM might not make sense for people who plan to keep their home for more than that. However, if you know you are going to move within a short period, or you don’t plan to hold on to the house for decades to come, then an ARM is going to make a lot of sense.10
Let’s say the interest-rate environment means you can take out a five-year ARM with an interest rate of 3.5%. A 30-year fixed-rate mortgage, in comparison, would give you an interest rate of 4.25%. If you plan to move before the five-year ARM resets, you are going to save a lot of money on interest. If, on the other hand, you ultimately decide to stay in the house longer, especially if rates are higher when your loan adjusts, then the mortgage is going to cost more than the fixed-rate loan would have. If, though, you are purchasing a home with an eye toward upgrading to a bigger home once you start a family—or you think you’ll be relocating for work—then an ARM may be right for you.
The Bump-Up-in-Income Earner
For people who have a stable income but don’t expect it to increase dramatically, a fixed-rate mortgage makes more sense. However, if you expect to see an increase in your income, going with an ARM could save you from paying a lot of interest over the long haul.
Let’s say you are looking for your first home and just graduated from medical or law school or earned an MBA. The chances are high that you are going to earn more in the coming years and will be able to afford the increased payments when your loan adjusts to a higher rate. In that case, an ARM will work for you. In another scenario, if you expect to start receiving money from a trust at a certain age, you could get an ARM that resets in the same year.
The Pay-It-Off Type
Taking out an adjustable-rate mortgage is very attractive to mortgage borrowers who have, or will have, the cash to pay off the loan before the new interest rate kicks in. While that doesn’t include the vast majority of Americans, there are situations in which it may be possible to pull it off.
Take a borrower who is buying one house and selling another one at the same time. That person may be forced to purchase the new home while the old one is in contract and, as a result, will take out a one- or two-year ARM. Once the borrower has the proceeds from the sale, they can turn around to pay off the ARM with the proceeds from the home sale.
Another situation in which an ARM would make sense is if you can afford to accelerate the payments each month by enough to pay it off before it resets. Employing this strategy can be risky because life is unpredictable. While you may be able to afford to make accelerated payments now, if you get sick, lose your job, or the boiler goes, that may no longer be an option.
The Bottom Line
Regardless of the loan type you select, choosing carefully will help you avoid costly mistakes. One thing is for sure: Don’t go with the ARM because you think the lower monthly payment is the only way to afford that dream house. You may get a similar rate at the time of reset, but it is a serious gamble. It’s more prudent to search for a house with a smaller price tag instead.