Real Estate Home Mortgages/Best Type of Mortgage to Get in California
QUESTION: My wife and I will be purchasing a new home in Temecula, CA in the next few months and need some advice on what type of mortgage to get. I will be getting a 5% down, conventional loan and am debating on whether to get a 30-year fixed rate or an ARM (5/1, 7/1, 10/1). I realize many people will say that the interest rates are so low right now that I should go for the 30-year fixed. My only hesitation in doing so is that I donít believe this will be the last home we will buy. I know we will be living in this home for at least 5 years but beyond that, I canít say for certain. The thought has crossed my mind to turn this home into a rental property once we decide to move again but am not sure if I want to be a landlord or pay a property management company. Another thought crossed my mind that if we do have a child while in this home, we may want to stay put longer.
In any case, I need some honest feedback/advice on whether it is worth it to roll the dice on an ARM or play it safe with a 30-year fixed given the information above? I have been told that because the interest rate is lower in the beginning on an ARM, that more is applied to the principal in the early years of the mortgage as opposed to a 30-year fixed where most of the payment in the early years goes towards interest. Letís say we donít decide to move away after 5 years or do turn it into a rental, better to take the chance with the ARM and refi to a fixed rate later if necessary? Or would we save more money in the long run by going with a fixed rate from the get-go? Which AR do we go with if we go that route (5/1, 7/1, or 10/1)? I appreciate your feedback on this. Thank-you.
ANSWER: Hi Mike,
As you begin to consider this option, it's important to understand the likely direction interest rates will be headed in the future. Because it is expected that the United States Government will be easing from the purchasing of mortgage backed securities, you should expect interest rates to rise from current levels into the next few years. No one knows exactly where they will find their new normal, but they will be at a higher rate than today.
Understanding that makes the ARM a little more risky. Ultimately, this decision should be based on your own commitment. If you feel strongly that you will sell in the next five years, an ARM is a good option because of the lower rate. If you feel like you may want to keep the property, and rent it out instead, or remain in the property beyond five years, the 30 year fixed gives you the peace of mind, stability, and budget-ability to work with.
Having that budgeted amount each month, that will not adjust, allows you to forecast rent schedules and cash flow that can make property management less uncertain, and would not require you to go through the expense of refinancing in the future, necessary if rates increase.
I also recommend paying more than the mortgage payment each month, so that extra amount is applied to principle. You want to try and eliminate mortgage insurance, as fast as possible, so you can have better cash flow on the property, if you decide to make it a rental in the future.
I would be happy to help you secure your financing for the purchase of your new home. I am licensed in California, and can help you no matter where you choose to purchase property. I look forward to hearing from you. Call me at 800-785-4952 to start the process and pre-approve you.
Senior Loan Officer
Universal Lending and Real Estate
---------- FOLLOW-UP ----------
QUESTION: I sincerely appreciate the feedback Joe. I do understand that the 30-year-fixed loan would offer the stability of a fixed, predictable payment, and that interest rates are surely to rise in the coming years. However, I am still on the fence as to whether this is the best option. I could always get a 7/1 or 10/1 ARM I suppose. Here are my thoughts and questions.
Wouldn't it be better to take a 5/1 ARM which will save me around $220 per month on my mortgage and apply that savings as extra payments toward the principal of the loan over the initial 5-year fixed rate period? I'm thinking that will enable me to pay down the principal faster while simultaneously eliminating the PMI at a faster rate as well. Also, even if the rate adjusts, I feel like with a lower principal and the rate adjustment cap, it may still benefit me more to do the ARM?
I've looked at an amortization schedule online that compared the 5/1 ARM and 30-year fixed loans that I have been looking at. While the 30-year-fixed resulted in more savings if the loan is carried to the full 30-year term, the 5/1 ARM saved more money on the total cost of the mortgage through year 20. It was only in year 21 that the fixed-rate began to have a lower overall cost. How realistic is it that I or anyone carries there loan to a full 30-year term?
That is why this decision is difficult for me. Since you are a loan officer, if you wouldn't mind, would you be able to run the same comparison I did with your current 5/1 ARM and 30-year-fixed rate with 5% down on a $265,000 loan? I'm curious if you see the same thing I do with the cost comparison of the two loans.
Again, thank-you for your assistance. It is greatly appreciated.
The answer to these questions are always answered by your intentions. ARMS are often times good decisions, if one chooses to own the home for shorter periods of time. Then those savings in a lower rate can be a benefit.
The problem with ARMS is that once the fixed period ends, they tend to adjust, and reflect a higher monthly mortgage payment. Because in your example it seems like you are unsure how long you want to keep the home, it would be my suggestion to err on the side of caution.
However, if you feel strongly, that you will be selling the home, in a shorter period of time, then it is worth it to analyze exactly what the savings would be over a 10 year period, comparing a 30 year fixed rate to a 7/1 ARM. But, ultimately, the risk is yours, and understanding that interest rates 7 years from now, will likely be higher than what they are today, makes the gamble considerable if you really enjoy the home, and do not want to sell in the next 20 years. Good Luck!