The Best Mortgage IS a Fixed Rate Mortgage
When shopping for a mortgage, one can easily become overwhelmed with all the different mortgage programs that are out there: Fixed Rates (FRM), Adjustable Rates (ARM), Hybrids, etc.
The problem that consumers face is "which mortgage is the best?" The answer to this is: the best mortgage program is that program that best suits the individual's needs. But how does one know which is the best, if one is not up on all the different types of mortgages?
Well, let's break mortgages down to their very basic levels: rate and term. Rate is the interest rate that one pays to bank. Rate is determined by risk. Term is the length of time that a loan is paid back. Term is also the length of time that the rate remains fixed (We will call this the rate term). The longer the rate term; the great the risk; the higher the rate.
Now, let's assume that all mortgages are FRMs and paid back over a 30 year term. Why? Most everyone understands the concept of a 30 year FRM: the rate is fixed for 30 years and paid back over 30 years. So, what this means is the 6 month, 1 year, 3 year, 5 year, 7 year, and 10 years ARMs are now all FRMs and paid back over 30 years. The rate is fixed for that period of time which is mentioned.
Going back to our basics, the longer the term the higher the rate. The 6 month FRM has a lower rate than the 10 year FRM. So, why would one take one of these shorter terms versus a longer term? The answer is simple: they have a general idea as to their future (they plan to move, add on, build a pool, refinance to take cash out, etc). The reward for planning ahead: a lower interest rate.
Even if a person is uncertain of where they will be in the future, if they use statistics, they can get a lower rate. Statistics show that the average homeowner refinances every 3-5 years and sells around 7 years. Let's say someone wants to be conservative on the 7 year figure, they can go for a 10 year FRM. They still will have a lower rate than that of the 30 year FRM. But, there are those still that do not even want to consider the risk of what happens after that 10th year of the FRM. For them, the 30 year FRM is best.
Now that I opened the can of worms on "what happens after the rate term expires," I will make a couple quick, simple answers. Assuming one misjudged their future expectations of their mortgage, they have a couple options.
- Refinance and base the new mortgage on the new expectations
- Refinance and jump start the expectations
- Ride out the adjustments.
Ride out the adjustments? Yes, after the rate term has lapsed, the rate may/will adjust. Every lender has different ways of capping what your rate can change, but they all have the same calculation on determining what the rate will be: Margin + Index. Margin is a fixed amount. It is the amount the bank charges to put it simply. Index is an adjusting rate that is determined by market factors. Enough said on this.
When does one let it ride? Simple answer: rates have dropped. Think back a couple years when rates were at record lows. One could have been in a 3 year FRM that was about to adjust. Instead of refinancing, one could have seen a drastic drop in their rate just by letting their rate ride. Even with a fixed margin, rates dropped low enough for those individuals to enjoy a lower rate without the need to refinance.
So what is the best mortgage for you? The best mortgage is the FRM that has the rate term equal to your future goals timeline and the amount of risk you are willing to take. Now, there are variations to these FRM programs, so talk to your mortgage professional to determine which program best meets your needs.