How to negotiate a first mortgage on a first home purchase.
Today’s topic is fixed versus adjustable mortgages.
Ann from New Jersey called in with this question:
Hi Money Girl. This is Anne from New Jersey. I was wondering if you had any tips for how to negotiate a first mortgage on a first home purchase. I have basically no experience in this area and I just want to make sure that I’m as informed as possible. Thanks.
Hey there Anne. Thanks for the great question. It’s a big question that people have actually written entire books to answer, and I’ll be giving away one of these books in a few moments.
Pick the Mortgage Loan That Suits Your Needs
But first, here’s a “quick and dirty tip” about one aspect of picking the right mortgage.
First, you’ll want to decide what type of loan suits your needs best. Loans fall into two basic categories: fixed and adjustable.
To get clear about the type of loan that’s right for you, ask yourself the following question: how long do I plan to keep my loan? This key question is the one that will influence your choice of loan type.
Do you plan to keep the loan and the house for a very long time? Do you think you’ll want to refinance after a few years to pull cash out of the property or for some other reason? Do you think you might sell the house in a few years to get a larger one or to downscale to a smaller one?
Fixed Rate vs Adjustable Rate Mortgages
If you plan to keep the loan for a very long time, say several years or longer, a fixed-rate loan would be a reasonable choice since fixed rates are still at relatively low levels historically. It also makes sense to get a fixed-rate loan if it’s really important to you that your payment stays the same each month for the life of the loan.
If you don’t plan to keep the loan for a very long time, you could come out ahead with an adjustable-rate mortgage or ARM. Adjustable-rate mortgages come with 1-, 3-, 5-, 7-, or 10-year fixed rate periods. There are also monthly adjustable loans called option ARMs that have flexible payment options (and the potential for deferred interest, also known as negative amortization).
You’ll want to make your best guess about the length of time you’re most likely to keep your loan. If you plan to refinance in, say, four years, then compare the rate of an adjustable loan with a five-year fixed-rate period to the rate of a 30-year fixed loan. If the rate of the 30-year fixed is equal to or less than the rate of the five-year ARM, all else being equal, it would make sense to choose the 30-year fixed.
On the other hand, if the rate of the five-year adjustable were lower and you were confident you’d keep the loan for less than five years, then it would make sense to go with the five-year adjustable.
The interest rates on fixed rate loans are usually higher than the rates on adjustable loans because fixed rate loans expose the lender to more risk if interest rates were to rise. However, we’ve been in a period where the rates of fixed loans have been very close to, and sometimes even better than, adjustable loans.