Are you paying more for your mortgage than you should be? If you're like a lot of other first-time home buyers, it's likely that you are.
And, fixing the problem could be as simple as choosing a new loan type.
As rents have climbed nationwide, mortgage rates have stayed low. According to Freddie Mac, 30-year conventional fixed rate mortgage rates have averaged below four percent since the start of the year; and rates for FHA and VA mortgage rates have averaged even lower.
For many buyers, though, the 30-year fixed rate mortgage is a wasteful choice. There are more logical, "less expensive" options to finance a new home.
An adjustable-rate mortgage (ARM), for example, can be a more suitable choice for a first-time buyer; and, for a buyer who intends to move or do a home refinance within the next 10 years.
ARMs offer lower mortgage rates than a fixed-rate loan and, sometimes, the savings is substantial.
The typical homeowner moves every 7 years. If you know you're going to move, then, why pay extra for a 30-year loan?Click to see today's rates (May 28th, 2016)
An adjustable-rate mortgage (ARM) is exactly what its name implies. It's a mortgage for which the interest rate adjusts over the life of the loan.
However, rates don't just adjust willy-nilly. The mortgage rates of an adjustable-rate loan are carefully controlled.
The majority of today's ARMs work like this :
Regulation protects mortgage borrowers from having to accept huge jumps in a mortgage rate on an annual basis. Mortgage rate changes are severely limited.
For example, with a 5-year ARM, the initial mortgage rate of the loan remains fixed for a period of 5 years. After the 5 years are over, the mortgage rate changes on the loan's "anniversary" every year for the next twenty-five years.
The new rate is often prescribed by the following formula.
(New Mortgage Rate) = (12-Month LIBOR Rate) + (2.25%)
This means that, after each adjustment, your new mortgage rate will be 2.25 percent plus whatever the 12-month LIBOR rate happens to be at that time.Click to see today's rates (May 28th, 2016)
Currently, the 12-month LIBOR is 0.82, which means that homeowners whose ARMs are adjusting today would be assigned a new, 1-year mortgage rate of 3.07%. Then, next year, the loan would adjust again.
Thankfully, there are limits to how much an ARM can change each year.
With a 5-year ARM, mortgage rates are typically limited to an adjustment of 2% per year except for the initial mortgage rate adjustment after the fifth year. At that first adjustment, rates are typically capped to an adjustment of five percentage points.
ARMs are also limited by how much they can adjust over their 30 years.
5-year ARMs, for example, are typically capped at a six percentage point adjustment over the life of the loan. This means that a mortgage rate which begins at 2.75% may never go above 8.75 percent.
Of course, ARMs can adjust lower, too, and for the last decade, they have.
Homeowners wise enough to take an ARM over a fixed-rate loan have beat the market pretty much every year since 2003.
According to Freddie Mac, 30-year mortgage rates currently average 3.86% nationwide for borrowers willing to pay an accompanying 0.7 discount points at closing.
5-year ARMs, meanwhile, average 2.91% with only 0.5 discount points.
This means that for a loan at the 2015 conforming loan limit of $417,000, a home buyer who opts for an adjustable-rate mortgage over a fixed-rate one saves $219 per month on their mortgage, plus an additional $834 in closing costs.
ARMs also come with initial fixed-rate periods of 7 years.
If you know you're going to move or refinance your home within the next 7 years, then, there's little reason to pay more to get the 30-year fixed. It's a loan you don't need.Click to see today's rates (May 28th, 2016)
According to the National Association of REALTORS® and its 2015 Home Buyer and Seller Generational Trends Report, the typical under-40 home buyer expects to live in their home for a period of 10 years.
The report also notes that "expected tenure is generally longer than actual tenure", which means that homeowners tend to over-estimate the number of years they'll spend in a house.
Indeed, the youngest group of buyers, the report says, tend to sell within five years of purchase, which makes them ideal candidates for the 5-year ARM.
There are a bevy of reasons why a "young home buyer" would move within 5 years of purchasing a home.
The first reason is that first-time home buyers typically comprise the single; the married without children; and, the married with children just beginning to save money.
These groups tend to search for what is commonly known as a "starter home".
A starter home, by definition, will be sparse as compared to a longer-term home. The amenities of a starter home are often fewer and the square footage is usually less.
Furthermore, for households with no children, there may be less heed paid to the home's school district -- all factors which can lower a home's sales price and make them
In cities such as Chicago and Boston, condominiums are the prototypical starter home.
Another reason why first-time buyers may move is for job-related reasons.
Younger homeowners are often more flexible with their life and career path than homeowners who are members other generations. Their jobs may require relocation as well -- especially among technology workers and those on management tracks within large corporations.
Lastly, first-time home buyers may move because, simply, they've outgrown their current living space. Younger households are more likely than older households to have additional children, which taxes the available space in a home.
There are plenty of homeowners feel like they've "run out of space" within months of having a baby.
For all of these buyer-types, the 5-year ARM can be a better fit than a 30-year fixed. It's less expensive at closing, less expensive each month, and less wasteful.
With a 5-year ARM, you pay for the years you need only. By contrast, with a 30-year fixed, you pay for predictability which will last you 3 decades.
The data shows you won't need it.
Home sales are rising and so are U.S. rents. Thankfully, mortgage rates are low. If you've been wondering whether it's a good time to buy, it may be smart to consider your options -- especially your option of taking an ARM.
Take a look at today's ARM mortgage rates now. Your social security number is not required to get started, and all quotes come with instant access to your live credit scores.Click to see today's rates (May 28th, 2016)
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
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2016 Conforming, FHA, & VA Loan Limits
Mortgage loan limits for every U.S. county, as published by Fannie Mae & Freddie Mac, the Federal Housing Administration (FHA), and the Department of Veterans Affairs (VA)