Which
Mortgage Loan is Better - 30 Year Fixed or 5 Year ARM (Adjustable
Rate Mortgage)?
(February 25th,
2008)
 Consumers
have to choose between the different range of mortgage products
available out there - from Adjustable Rate Mortgages (ARMs), 30
year fixed term, balloon mortgages, jumbo loans and more. In this
article, we will differentiate between choosing a 30 year fixed
mortgage and a 5 year adjustable rate mortgage. Which one of the
two is better? The answer is, it depends on how much of a home
you can afford. There is no right definitive answer as to which
is better. The consumer has to look at his financial need and
his short/long term financial goals.
Some people don't like change. These are the
conservative people who value long term financial security and
a 30 year fixed term mortgage provides just that; a mortgage rate
& payment structure that will not change with market conditions.
Instead of worry about how much they will pay in interest this
month, these people will be able to sleep every night peacefully.
The major disadvantage of 30 year fixed term mortgages to lenders
is the increased amount of long term risk and the time value of
money. The banks will figure they are tying up their money in
a fixed interest rate investment for a 30 whole years; who knows
whether the borrower will even be able to repay that loan back?
And what if mortgage rates move higher in those 30 years; the
bank will lose money due to opportunity cost!
This is why it is more expensive to borrow a
30 year fixed mortgage than a 5 year ARM. Lenders want to be compensated
for the increased risk of lending a 30 year loan, that is why
the interest rate difference between the two is usually 1-2%+.
Between the 30 year fixed and 5 year ARM, which one should consumers
therefore choose? Borrowers should look at the timeline of their
lives for the next 5 - 15 years. How long will they want to occupy
the house? For example if you expect to call the moving trucks
in another 7 years, there is no reason why you should opt for
the 30 year fixed term mortgage and pay a higher interest rate
for it.
If you select an Adjustable Rate Mortgage (ARM),
the lender will lock your rate for 6 months - 2 years. After that,
your interest rate will fluctuate with current market rates. This
way, the bank does not tie you in for a 30 year fixed rate, thereby
reducing their risks of opportunity cost + time value of money.
This usually means a reduction in interest rates for you.
Related Articles
Beware
of Option ARM (Adjustible Rate Mortgages)
There is a new but very dangerous player in
the mortgage industry; it is called Option Adjustible Rate Mortgage
(ARM). This is a very complex loan that if not understood properly,
could ultimately cost you your home! Option ARM is a type of mortgage
plan with as many as 4 different monthly payments and an interest
rate that could fluctuate month to month!
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