Fixed or adjustable rate mortgage?
Having decided to refinance, one of the most significant decisions you will have to make is whether to get a fixed rate mortgage or an adjustable. Although for economists this is a very complex question, for the average borrower it boils down to consideration of two fairly simple questions, one factual and one emotional.
The factual question is, how long do you plan to keep this property? If you know that you are going to be selling the property within 3 to 5 years then clearly you should get an adjustable rate mortgage. The most common adjustable rate mortgages have fixed interest rates for either the first 3 years of the first 5 years. Both 3 year and 5 year ARMS will offer better rates than a 30 – year fixed. Why pay a higher interest rate to lock that rate in for 30 years when you know that you will actually only have this mortgage for 3 years? (The same is true if you know that you are planning to refinance again in 5 years in order, for example, to buy a vacation property).
If you do not plan to move or refinance within 5 – 7 years, then your decision becomes purely an emotional one. (We will ignore the tiny, probably non-existent, percentage of the population that can accurately predict interest rate movements for the next 7 years). The question becomes, do you like to take risks? If so, chose an adjustable rate mortgage knowing that you will have a lower interest rate for some period of time and, if rates stay flat or go down, you will save even more money. Of course, the risk is that rates will rise and at the end of your 3 or 5 year fixed interest period, you may find your monthly payment going up and up each year.
If you are the more conservative type, then you should chose the 30-year fixed. Sure, to start with you’ll be paying more each month than your risk-taking neighbor but you’ll never have to worry about the vagaries of the economy and what impact they will have on your monthly mortgage payment. (Keep in mind that the average 30-year fixed mortgage only lasts 4.9 years. This means that the majority of Americans are paying a much higher rate than they have to but actually getting no benefit from it.
For a different type of mortgage program that combines the low payment of an adjustable with the peace of mind of a fixed rate, see question 10 at the end of this refinance guide.
How much will closing costs be? Will I have to pay a penalty if I re-finance and pay off my current mortgage early?