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Is a 30-Year Fixed Rate Mortgage Right for You?
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When people consider whether to get a fixed rate mortgage or an adjustable rate mortgage, they come out in favor of the fixed rate mortgage by a margin of two-to-one. It shouldn't be a surprise to anyone that the 30-year fixed rate mortgage is still the most popular mortgage. But as a borrower, are you really considering all of the important points when deciding what type of mortgage best suits your situation?
The following fact alone speaks volumes on this issue and should cause borrowers to seriously consider whether a 30-year fixed rate mortgage is appropriate for their circumstances: Ninety percent of mortgages are paid off within seven years.
Not only do people move more often than they think they will, but changing interest rates and economic needs cause people to refinance. Despite the fact that most people don't need a mortgage more than seven years, a majority of people opt for the 30-year fixed.
I'm not saying that the 30-year fixed isn't appropriate for some people, but is it the mortgage of choice for all the wrong reasons? Let's face it, it's the easiest to understand. It's a low maintenance mortgage. It doesn't require you to track the mortgage market to see if your rate will be going up or down in the future.
Young homebuyers will move as their families grow, their incomes increase, or as their careers take them elsewhere. So obviously a 30-year fixed rate mortgage is overkill for them. We now live in a society that is much more mobile and with families that are growing at a much later stage in life. We are moving jobs and homes later in life and more often than our parents did.
On a national level, the number of borrowers opting for an adjustable rate mortgage has been growing as a percentage of all loans closed. The driving force behind this trend according to a Consumer Reports survey is "the lure of affordability." The lower interest rates and payments of adjustable rate mortgages are financially attractive to people trying to buy homes that have appreciated dramatically over the last few years. During this real estate boom, the rate of home prices has exceeded the rate of personal incomes. So people are looking for ways to make the home they want more affordable.
Borrowers with adjustable rate mortgages need to understand that they are getting a lower rate in lieu of the "insurance policy" built into a 30-year fixed rate mortgage. That's really what you're paying for with the higher interest rate of the 30-year fixed rate mortgage; an insurance policy protecting you from interest rate increases. But the price of this "insurance policy" can be costly. For example, on an $800,000 loan you would pay almost $27,000 more in interest payments over 5 years if you opted for a 30-year fixed rate mortgage over a 5/1 adjustable rate mortgage.
So it only makes sense to opt for the 30-year fixed rate mortgage if your long-term plans are clear.
Therein lies the challenge. Most people don't know where they'll be next year, much less 5 years from now. One thing that is generally true for the majority of people is that their incomes will be higher in the future. And this will ease the burden of higher interest rates if borrowers are in adjustable rate mortgages past their initial fixed terms (i.e. into the sixth year of a 5/1 ARM).
In summary, most people don't need a 30-year fixed rate mortgage. The facts clearly show that they would benefit from an adjustable rate mortgage. However, it might just take 30 years to figure out their "short-term" plans.
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