Conventional wisdom states: Current mortgage rates are close to record lows and, given that eventually they’re pretty much bound to rise, you’d be mad not to choose a fixed-rate mortgage (FRM) that locks your interest rate for the term of your home loan. True for many, but not for everyone — maybe even fewer people than you’d think.
The alternative is an adjustable-rate mortgage (ARM), and most of these are “hybrids.” You may have read about 5/1 ARMs or 7/1 ARMs, and that five or seven represents the number of years during which the initial mortgage rate is fixed before it floats up (or, much less likely, sinks down) to whatever rate is then current. It’s a hybrid of an FRM for the first x years, and an ARM after that.
Home loans should match your plans
It’s usually more advantageous to choose the type of home loan that matches your plans. If you want to apply for a mortgage — or refinance an existing one — on a home you plan to remain in indefinitely, then an FRM makes perfect sense. A quick glance at Freddie Mac’s archive of 30-year FRM rates confirms how much they can go up and down over the term of a loan.
It’s a no-brainer for those settling into their home for decades: fix your rate with an FRM. In the unlikely event interest rates fall by a significant amount, you still have the mortgage refinancing option. But what if you’re likely to move in a few years?
ARM yourself if you’re a frequent mover
According to the U.S. Census Bureau: “In 2010, 37.5 million people 1 year and older changed residences in the U.S. within the past year.” That’s 12.5 percent. So even during a recession, Americans moved on average once every eight years. Look online, and you’ll likely find once every five or seven years frequently quoted.
That’s no surprise. People tend to start off in small houses or apartments and buy bigger homes as kids come along, elderly dependents move in, or they become wealthier and trade up. And, of course, many have to relocate frequently for employment. These people should perhaps explore hybrid ARMs.
Current mortgage rates lower for ARMs
That’s because the initial mortgage rates for these home loans tend to be much lower than those for FRMs. Take weekending October 26, 2012. According to the Mortgage Bankers Association, the rate for 30-year FRMs averaged 3.41 percent, with points of 0.76 (including the origination fee) for 80 percent loan-to-value loans. The equivalent average 5/1 ARM rate was 2.66 percent with points of 0.33.
Of course, if your plans change and you stay put, you might regret opting for an ARM when its initial fixed rate expires. But you may regret even more paying unnecessarily high rates when you’re packing your moving van in five or seven years’ time. Those are risks only you can weigh up.
Peter Andrew has over 25 years of experience writing about marketing, advertising and management. He regularly covers consumer credit card topics for IndexCreditCards.com and other personal finance publications including Fox Business, TheStreet and MSN Money. He also writes frequently about mortgages and auto loans. Peter has spent extended periods living overseas, in the UK, France and Africa. He lives with his partner of 20+ years, and wastes too much of his time on cryptic crosswords.