Chapter 7. - ARMs and Legs: Fixed Mortgages Aren't for Everyone (Zillow Talk #7)
Updated: Dec 19, 2021
How long have you lived in one house? Let’s look at some statistics in the United States.
-In the United States, on average, people live in one house for 7-8 years and move.
-In the United States, people change jobs on average once every 4.6 years.
-In the United States, divorce after an average of 8 years of marriage.
In most of the above cases, you have to move from a house to another house. Meanwhile, none of that is close to 30 years. But why would most of the home buyers choose a 30-year fixed mortgage without considering other options?
Have you ever spent time shopping for a loan when buying a house?
Here is something I always say to my customers. When you buy a car or a bag, everyone does a lot of research in advance, right? How much is a car or bag?
Now, think about a house and its mortgage. Yes, houses are expensive. Even a distressed house is almost $100K. Therefore, the interest paid on the loan you get is also ridiculously large.
If you take some time to choose your loan wisely and lower your interest a little bit, you will save money for buying a few luxury bags while staying at the house. However, US home buyers spend 4.5 hours choosing a mortgage on average. Honestly, before I entered the real estate industry, I chose a loan program recommended by the bank without any hesitation when I bought my house. Again, think about how much time you spent researching or shopping when you bought your last car, and when you chose your mortgage when you bought your last house.
Please take time and shop multiple mortgage programs before you sign one.
Now, what are some of the home loans existing out there?
There are two main types of home loans.
1. Fixed-Rate Mortgage (FRM)
A loan that keeps the same interest rate from the beginning to the end of the payment period. This means that if you get a 30-year loan at a fixed interest rate of 3.5% (30-yr FRM), you will maintain the 3.5% interest rate for 30 years. In most financial institutions, two payment terms are typical, 15 years and 30 years. In 15 years, the principal is paid off for 15 years, so the monthly payment is larger, but the interest rate is much lower than in 30 years. In other words, you pay less money to pay for the bank.
2. Adjustable Rate Mortgage (ARM)
During a certain period (usually 1, 3, 5, or 7 years) from the beginning, the mortgage proceeds in the same way as the FRM, and after that, the mortgage interest fluctuates according to the market interest rate at that time. It usually changes every year or every six months. (This is known to be different for each financial institution and for each program. Some programs change their interest rate monthly.)
The notation is expressed such as “ARM 5/1”. This means variable interest mortgage (ARM), FRM for the first five years, and the interest rate changes once a year after that.
Always ARM’s interest rate starts with a lower interest rate than FRM’s interest rate
The important thing is, ARM starts with a lower interest rate. You can see this by looking at the graph at the top of this article. As you may have noticed, the low-interest rate means that you can bigger buying power with the same money, or that even if you buy the same house, your monthly payment will be lower.
However, interest rates on ARM fluctuate. So, you need a thorough plan.
As shown in the graph at the top of the article, ARM also fluctuates like FRM. However, FRM is one that goes straight at a set interest rate, and for ARM, the interest rate fluctuates according to the graph above. In other words, at some point, the ARM’s monthly payment could be higher than the FRM’s. (For example, if you use FRM in 2004, you have to pay about 5.5% interest in 2008, but in the case of ARM 1/1, you have to pay an interest rate of 5.7% in 2008.)
Therefore, you need a thorough plan. Consider carefully how many years you will live at the home you are buying now, and if you plan to live in it for 5 to 7 years, you can consider a loan with ARM 5/1 or ARM 7/1 to benefit from a lower interest rate while you are living there. Even when the interest rate becomes really low, it is possible to refinance an ARM to an FRM.
The bottom line is, please take time and shop your mortgage loan carefully. The right mortgage program can give you big differences in your finance.
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