The low interest rates we have seen in the past several years have motivated many current homeowners to refinance their high-interest mortgages. These low rates have also resulted in an influx of first-time homebuyers into the real estate market.
To play things safe, many real estate agents, and also mortgage brokers, push clients to finance their homes using fixed rate mortgages because this type of mortgage is deemed the safest. However, applying for 15-year and 30-year fixed rate mortgages with the help of a mortgage broker in Denver may not make sense in every situation. For example, if homeowners know with reasonable certainty that they will be moving or selling their home within the next 3, 5, 7, or even 10 years, an adjustable rate mortgage (ARM) might make more sense. The reason is that the initial interest rates on ARMs are not as high as the interest rates in most fixed-rate mortgages.
Here’s an example of a situation in which a 5-year ARM makes financial sense:
- If the balance on your mortgage is $250,000 and you have a fixed interest rate of 4.875%, you will pay $11,250 per year in interest.
- If the balance on your mortgage is $250,000 and you have an ARM interest rate of 3.25% you will pay $8,125 per year in interest.
- Using the above numbers, you would save $3,125 per year in interest with an ARM.
- In fact, if you finance using an ARM in the above scenario you would save $15,625 over 5 years.
Why would you want to pay a lender so many thousands of extra dollars with a fixed rate mortgage if you are fairly certain you will own the property only for 3, 5, 7 or 10 years? It simply doesn’t make sense! ARMs are available in terms of 3, 5, 7 and 10 years, which make your options fairly flexible.
Who Should Not Seek an ARM?
Individuals who are not reasonably certain they will either move or sell their homes within the time frame of the ARM do run a significant risk that their mortgage interest rates will adjust to an unreasonable number once the term of the ARM term expires. This can create an unfavorable financial situation and is usually not worth the risk.
Who Benefits from ARMs?
- Homeowners who want to keep their monthly payments as low as possible.
- Homeowners who know they will want to sell their property within a certain time frame.
- Homeowners who know they will retire and plan to sell their homes when they reach a certain age (within the next 3, 5, 7, or 10 years).
- Homeowners who are fairly certain they will have to sell their home within the next 3, 5, 7, or 10 years because of an impending job transfer.
Who Does Not Necessarily Benefit from an ARM?
- Homeowners who intend to pay off their loan as quickly as possible.
- Homeowners who know with a great deal of certainty that they will not sell their homes in less than 10 years.
- Homeowners who do not feel comfortable with the prospect of an eventual, and possibly much higher, interest rate adjustment.
There are pros and cons associated with every type of mortgage. For example, a 15-year or 30-year fixed rate mortgage provides the security of constant monthly payments. However, fixed rate mortgages require a higher interest rate. In contrast, ARMs are less expensive in terms of the amount of interest paid, but these mortgages come with an inherent degree of uncertainty because after the term expires, they will inevitably adjust to higher interest rates.
If you are considering an ARM, you should take great care to understand the risks before signing on the dotted line. Make sure you are adequately informed by a reliable Denver mortgage broker about the loan terms and how your interest rate may increase in the future. Since it’s nearly impossible to predict the future, it’s important to be informed and aware of how the ARM might affect you financially in all possible scenarios.