5 Year Adjustable Rate Mortgage vs. Fixed Rate Mortgage

I was talking with my brother the other day, and found out he is going to refinance his home mortgage from a 30 year fixed rate Loan to a 5 year adjustable. Well this set off an argument. I mean, what is he thinking? America is just now barely getting out of the worst housing economies in our history. The majority of that problem had to do with people buying homes they really couldn’t afford, with adjustable Loans, that if interest rates change, they are in deep trouble and can no longer afford the mortgage payment.

Now, for full disclosure my brother has come into some money and could probably pay off his house free and clear if he wanted to, but the debate still arises which loan is better 5-10 year adjustable or 15-30 year fixed. I know this is a tricky question because every person’s situation is different and no one loan is right for everyone. So here are a few questions you need to ask yourself: 

1. How long are you planning on living in your house? - It used to be that the average home owner refinanced or moved every 7 years but that has changed with the resent housing downturn and industry standard changes. It’s much more difficult for homeowners’ to do cash-out refinance. Also, I think it’s a good idea to just assume that you’re going to live in your home for at least 15 years. I’ve heard many homeowners say “ We’ll move in 5 years or less.” Then 15-20 years later they are still there.
2. Can you really afford this home? - Lending practices are very stringent right now and should keep you in-line. But remember, homes are expensive, they require a lot of upkeep. Just try and think of all the costs before you jump in.
3. How safe is your job? - I know people with some of the safest jobs have been let go. Think about if you did lose your job, how hard would it be to find a new one. Do some research just to be sure.

Now getting back to my brother, lets use his loan scenario just to make things easy, even though I know it may not apply to everyone.

He has a $500,000 30 year fixed loan at 5.75% and has owned the home for about 5 years, and wants to refinance to a 2.85% 5 year adjustable, which means it’s fixed for 5 years and can adjust 1% per year after that with a max increase of 5%. His thinking is, that he will save 2.9% per year, over the next 5 years, which would save him $850 per month or $51,000 over 5 years, which is good. Now, he is thinking of making double payments so he would pay $4134 per month and would pay off the mortgage in 12 years, and pay about $90,000 in interest.

5 Year Adjustable Rate Mortgage vs. Fixed Rate Mortgage 

Let’s look at 15 and 30 year loans. On the 15 year loan, is at about 3.45%, your payment would be about $3,562 and would pay about 141,181 in interest.

The 30 year loan is at about 4.28% his payment would be $2,476 and would pay about $390,768 in interest.

So, in review it looks like his idea is good, because he would save a lot in interest, but if he can make double payments on the adjustable he could make double payments on the 15 or 30 year loans as well. If he did that, he would pay off the 15 year loan in just 9 years and would pay about $59,291 in interest and on the 30 year loan he would pay it off in 11 years and would pay about $121,876 in interest.

But now let’s look what would happen if you got a the 30 year fixed loan and invested the extra payment into something relatively safe, like a municipal bond, which is tax free and nationwide pays about 5% (some states pay much higher).

So that $2,476 payment invested every month, would be in 30 years, “drum roll please” $2.1 MILLION dollars, and at the same time you get the tax write off! Now, as you can see investing that money is far better than paying off your mortgage!

Also in life, as you all know, “stuff happens”, meaning people lose their jobs and get sick, so keeping your large bills, such as your mortgage to a low fixed payment is a smart move, whether you can make double payments or invest your extra money, you’ll be less burdened if life takes an unexpected turn.

And as for adjustable loans it’s too much risk and I think it is not a smart move. Lock in your rate and you can sleep well at night.

5 Year Adjustable Rate Mortgage vs. Fixed Rate Mortgage

by Mark Curtis