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Fixed- Versus Adjustable-Rate Mortgages
Should I choose a fixed or adjustable mortgage?
By Kimberly Lankford, Contributing Editor, Kiplinger's Personal Finance
December 20, 2002
Mortgage rates are currently near their lowest point in 40 years, which would make a fixed mortgage look like your best bet -- letting you lock in today's low rates for the next 30 years. But that isn't always the case.
The rates for adjustable-rate mortgages (ARMs) are much lower then they are for fixed mortgages -- around 4.6% for one that locks in the rate for five years, versus 5.7% for a 30-year fixed mortgage, according to BankRate.com. On a $250,000 loan, that translates into a monthly payment of $1,287 for the ARM versus $1,451 for the fixed mortgage -- or a savings of about $2,000 per year. Over five years, you've saved $10,000 by going with the ARM. That extra cash can be particularly valuable if you're struggling to pay your monthly bills or make the maximum contributions to your 401(k) or IRA.
But ARMs come with a giant risk: After those five years are over, the rate can rise significantly. They usually have a cap on the price hike, but some can increase by 5 or 6 percentage points.
Your decision depends on how long you plan to stay in the home. If you plan to move before the adjustments to your interest rate begin, or shortly thereafter, you can walk away with significant savings. However, if you plan to stay in the house ten or 20 years, you might as well lock in today's low rates. Compare the costs and benefits with this calculator.
Look for an ARM that fits with your plans for the house. The five-year and seven-year versions tend to be the best deals -- with the seven-year averaging about 5.1%, which is a monthly payment of $1,359 on a $250,000 loan. Ten-year ARMs are also available, but their rates aren't much lower than the 30-year versions. And one-year ARMs offer incredibly low rates -- 3.95% -- but the risk is too high that the rate will jump before you sell your house.
Go to BankRate.com and get rates in your area for several types of mortgages. Then plug the numbers into the loan calculator to see how the rates affect your monthly payments.
