United States: Is Now The Time to Lock In A 30-Year Mortgage?

Last Updated: May 16 2017
Article by David White

Buying a home is one of the most exciting and expensive purchases you will make. Whether you are buying a new home for your growing family, a vacation home for the summer or winter, or an investment property, deciding how to pay for it is just as important of a decision as it is to pick the house that is right for you. How you choose to finance such a major purchase can have a significant long-term impact on your finances. If you are purchasing your home and are considering a mortgage loan, understanding the main types of mortgages and what benefits they can provide will help you determine which mortgage is most appropriate.

Fixed-Rate Loans Offer Stability
Fixed-rate mortgages are the most common loan type and offer the most consistency for your monthly expenses and budget. These loans have interest rates that remain constant for the life of the loan, which are typically "15-year" or "30-year" length mortgages.

Having a shorter mortgage term results in a greater monthly payment in order to pay the loan off sooner, but results in greater savings as less interest is paid over the life of the loan. Fifteen-year loans also tend to have a lower interest rate than 30-year loans.

For longer term loans, a 30-year mortgage typically has a smaller monthly payment and may be easier to budget, but will result in more interest expense as the loan takes longer to pay in full, and has a higher interest rate.

The most significant benefit of a fixed-rate loan is consistency and knowing what your mortgage payment will be each month. Interest rates in recent years have been historically low and many buyers have been able to take advantage of this, resulting in substantial savings. Interest rates typically increase after an extended period of low rates. By locking in a low fixed-rate loan, you do not have a risk of potentially higher monthly payments if interest rates rise. The amount you pay remains the same no matter how interest rates fluctuate.

The Federal Reserve has recently raised interest rates several times, and indicated they will continue to raise rates going forward.  Now is an excellent time to lock in a low fixed-rate mortgage, as rates are expected to continue to rise. No one is able to predict, with certainty, the direction of interest rates; however, we are currently at historically low interest rates—4% versus 1980's interest rates of 18% for 30-year mortgages.

With fixed-rate loans you are protected from increasing interest rates; however, the disadvantage is that if interest rates fall below the rate you borrowed at, your payment would remain the same and you could not take advantage of the lower rate. You would be paying more than you would if you borrowed at the new, lower rate. However, you may have the option to refinance your loan to take advantage of the lower interest rate. Refinancing can be beneficial and lower your monthly payments; however, the fees involved may not make it worthwhile. Another disadvantage of a fixed-rate mortgage is that these loans may be slightly more expensive and come at a premium in comparison to other mortgages in order to account for the advantages provided by consistency and predictability.

Fixed-rate loans are a standard financing option that work well for many buyers looking to live in their homes for at least a number of years. The stability of the fixed-rate works in a borrower's favor when interest rates rise, but work against you should the rates decrease. Refinancing is an available option, but may not be cost-beneficial depending on the individual situation.

ARMs Provide Flexibility
Adjustable-rate mortgages (ARMs) differ from fixed-rate mortgages in that they offer a fixed interest rate for an initial period of years and fluctuate thereafter. These mortgages are generally at lower rates than a comparable fixed-rate mortgage. The catch, however, is that the interest rate resets periodically.  A 5/1 ARM means the interest rate is fixed for the first five years of the loan and will adjust every year after that—by an unknown amount falling within a range specified in the loan document, with preset maximum annual limits.  The adjustment is based on the market interest rates at the time of the adjustment.

Some buyers may be uncomfortable with a fluctuating mortgage payment; however, it can result in some sizeable savings and be advantageous to some borrowers. The appeal of this type of mortgage is the lower payments in the first years of the mortgage, resulting in increased cash flow and opportunity for you to make other investments. ARMs may also be well suited for you if you plan to sell your house before or shortly after the initial fixed-rate period.

A caution for borrowers: should you be unable to sell the house before rates increase or your income changes, it is important to consider if you would be able to afford the increased payments. This was a common issue that occurred during the housing crisis in 2007. Borrowers were unable to sell, refinance, or afford the higher payments, and thus the properties were foreclosed.

While ARMs may offer less stability than fixed-rate mortgages, if used correctly, it can be a useful tool in financing home purchases and investment opportunities and result in long-term savings.

For Luxury Properties, Think Jumbo Loans
Fannie Mae and Freddie Mac are government-sponsored, standard-setting mortgage entities that back most mortgages throughout the country. These organizations set borrowing limits and are used in the typical home purchase. The majority of loans by banks are sold to one of these organizations after closing, and thus banks conform to their standards.

For the high-end luxury property or a beachfront vacation home that is more expensive than the average home purchase, you may need to borrow more than the limits set by Fannie Mae or Freddie Mac. With these larger home purchases, "jumbo" mortgages may be necessary. Mortgages are considered jumbo if you borrow more than $417,000 in most parts of the country, or $625,000 for areas such as New York City or San Francisco, where real estate is more costly.

Many banks offer jumbo loans to purchase these luxury properties, but these loans are not backed by Fannie Mae or Freddie Mac. The banks tend to impose stricter financial qualifications and often have higher interest rates for these loans than those that would normally be backed by Fannie Mae or Freddie Mac.

Because these loans may be more expensive or difficult to obtain, it is important to shop around to get the best rates. Jumbo loans are also available in fixed-rate and ARM varieties.

Choosing the Right Mortgage
Just as every property is unique, the best financing option for each home buyer's situation will differ. If you are purchasing a second property or vacation home, the financial requirements are stricter in comparison to purchasing a primary home.

While there are multiple options to finance these purchases with any of these mortgage types, it may be currently most cost-effective to lock in a historically low fixed-rate mortgage. Regardless of whether you are purchasing a new home or second home, knowing your options can help ease the buying process and help you make an educated decision about your long term finances.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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David White
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