When an adjustable rate mortgage is OK
If you’re looking into buying a home, especially if it’s your very first home, you may be amazed and somewhat confused at the dizzying array of options available. One that many lenders like to advocate for first-time homebuyers is the adjustable rate mortgage. This type of mortgage is enticing because of its initially low rate, but as the name implies, this rate is subject to change, sometimes by a significant amount. While Realtor.com noted that many will advise borrowers to steer clear of an adjustable rate mortgage, there are a few circumstances in which it might make sense.
“The average American will move 11 times in his or her life.”
Moving is a possibility
Adjustable rate mortgages are most popular with first-time homebuyers. This is due in part to the strong financial case that can be made for such a buyer to sign up for a loan with a changing rate. According to writer Mona Chalabi, who analyzed U.S. Census Bureau data for FiveThirtyEight.com, the average American moves about 11 times within his or her life. That’s why many caution against first-time buyers signing on for a long-term fixed rate mortgage. Fixed rate mortgages could help you save thousands over time, but that’s only if you want to stay there for the life of the mortgage.
The very nature of the first-time homebuyer – young and still figuring things out – is not always conducive to a 15- or 30-year commitment like a fixed rate mortgage. If you don’t know where you might be financially or even physically in five years, an adjustable rate mortgage may work out in your favor. This is provided you can exit before the rate spikes higher, usually after the first five years.
Your options are limited
As a first-time buyer, options for financing are notoriously small. Short credit histories and a lack of capital are two of the most common things that can keep younger buyers down. Banks are hesitant to lend long-term mortgages to first-time buyers because they represent outsize risk that they may lose money on the deal. This means first-time buyers could either get charged an exorbitantly high rate, or simply denied any loan at all.
In these cases, an adjustable rate mortgage is usually a more realistic option. Lenders are more likely to approve first-timers for these loans, and monthly payments are often much lower. Down payments are also typically much more manageable as well. Realtor.com noted that if you can secure an FHA loan, these may require as little as 3 percent down. The big downside to this strategy is the buyer will absorb much of the risk inherent in these loans. If mortgage rates start to go up, the rate on the adjustable mortgage likely will as well. According to CNN Money, mortgage rates on average are very low right now and have been for some time. This is good for buyers now, but won’t last forever. The longer rates stay low, the more risk there is they could creep up again, which could create a big spike in payments.
Is a typical mortgage better?
If you’re considering an adjustable rate mortgage, it’s also worth running the numbers on where you might be with a 15- or 30-year fixed-rate loan. According to Time Magazine Money, the 15-year fixed rate mortgage may be among the best bets for those looking to buy in relatively affordable markets. As they explained, a larger portion of your monthly principal payment goes toward paying off the full loan amount with a 15-year fixed rate mortgage. In a market where home values are about average, they are likely to increase faster than in cities where housing is already expensive. That means if you can pay off the principal faster, as is possible with a 15-year fixed rate mortgage, you’ll be able to build equity sooner. On top of natural appreciation of the home’s value, a 15-year mortgage may be the most financially savvy bet for those willing to make a slightly longer-term commitment.
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