Best Mortgage Type for You?

Q) I need to refinance my mortgage this year, and I am trying to decide what the best loan option is for me. My friends and family have told me to stay away from adjustable rates, but it seems like I may get a better payment that way. What are the pluses and minuses of adjustable rates versus fixed rates?

A) This is a great question and it will depend a lot on your unique situation, long- and short-term goals, and how long you intend to be in your home. Let's take a look at both options and who might benefit from the different loan types the most.

Adjustable rates mortgages, also known as ARMs, have received a lot of bad press over the last few months in the news. However, when you know the ins and outs of an ARM you might find it meets your situation better than a fixed-rate loan. An ARM works like this: The interest rate is typically lower initially than a fixed rate, and in many instances this rate is fixed for a pre-determined amount of time--say three, five, or seven years. At the end of the fixed term, the rate adjusts based on several factors, a fixed margin (usually between two and four percent) and an adjustable index, like the Wall Street Journal Prime rate. The amount your initial rate can go up or down is also governed by "caps" usually two to six percent above or below the initial rate. Despite these caps, which are designed to protect the borrower, there can still be a large payment shock if your rate goes from five percent to 11 percent.

So who are these types of loans best suited for? Here are a couple of scenarios where an ARM may make more sense than a fixed rate:

1. You know you are moving out of the home before the ARM is set to adjust, and want to take advantage of the better rate.
2. You have gone back to school, and need the lower payment for the next three to five years while juggling the costs of school, home, family, etc.
3. You are taking the savings you gain with an ARM to pay down other, higher interest debt.
4. You have children in college, and need a lower payment for the next few years to support them.

Fixed-rate loans are still the most popular type of loan because of the payment security they offer. Fixed rate loans are traditionally offered in 10, 15, 20, 25, 30, and now 40 year terms. When you refinance with a fixed-rate mortgage, let's say for this example a 30-year fixed rate, you will have a payment that will never fluctuate, and will pay the loan off in 360 equal payments. Traditionally, the longer the term of the loan, say 30 years vs. 15 years, the higher the interest rate will be. So in some instances a shorter term will allow you to pay off your mortgage faster, and at a better rate.

So who is best suited for this loan?

1. People who will be in their home long-term and want payment consistency
2. People that are on a fixed income
3. People adverse to the risk of an adjustable rate
4. People in a declining housing market

As you can see, both loans offer distinct benefits for different situations. The key as always is to assess your personal situation, work with a reputable lender, and customize a loan to meet your needs.

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