When I heard that interest rates were going up again, I decided it was time to look into refinancing my mortgage. I first talked to my mortgage company.
"I want a fixed rate on my mortgage." I said.
"Could you tell me why that is?" The broker asked in a friendly way.
"I don't want to take the chance that interest rates will go up. At my age, I can't take that chance."
"If you look at the last ten years, the adjustable rate has worked out pretty well for you. In fact, you had paid less interest than most people with a fixed loan. May I suggest that we look at some adjustable rates? They are even lower than the rate you are paying now, and with caps, you don't have to worry about the interest rate going up. I think we can lower your monthly payment by a few hundred dollars."
The broker took a break at this point so I could say, "Sorry, but no. I'm only interested in loans with fixed rates." "I don't understand. You don't want to save money, do you?" He asked this before starting a talk that was a mix of economics 101, budgeting 101, a little fortune telling, and a healthy but totally unrealistic optimism about how interest rates will change in the future.
When he was done, I told him that in the early 1980s, mortgage loans had interest rates between 18 and 19 percent, which he seemed too young to remember. I pointed out that 18 percent interest on a $100,000 loan is $1,500 per month just for the mortgage interest. If you have a $200,000 loan, you would have to pay $3,000 per month just for the interest.
I knew he thought I was crazy when I talked about an 18 percent interest rate on a mortgage in the current market. At the end of the call, we didn't come to any conclusions. It wasn't about fixed-rate mortgages vs. adjustable-rate mortgages that people didn't understand (ARM). There was a big difference in age, experience, expectations, hopes, and fears.
Let's look at mortgages with rates that change over time to see why there is a gap. This type of mortgage loan usually has a lower rate than a fixed-rate loan, and a lower rate means a lower monthly payment, which makes it easier to qualify.
When you apply for a mortgage loan, the lender looks at how much of your income can be used to pay back their loan. If you make $5,000 a month, a $2,000 loan payment takes up 40% of your income, while a $1,000 payment takes up 20%. The loan is easier to qualify for the closer you are to $1,000 or 20% of your income. This makes it easier for young people just starting out and people with low incomes to qualify.
Adjustable mortgage rates are attractive to young people who are naturally optimistic, who hope to make more money, and who might move to a different home in a short amount of time. They should think about what they can pay and not worry too much about what will happen in the far future. Anything is better than renting, which is a waste of money in their eyes.
There are also older people who have had some bad luck in their lives and don't have a high credit score or a very high income. Since a bad credit score makes the interest rate a bank gives to potential borrowers go up, these people may not be able to afford a fixed rate.
Let's look at some words that will help you better understand ARM.
Margin: This is the lender's markup, which is also how they make money. When you add the index rate to the margin rate, you get your total interest rate.
ARM Indexes: These are the standards that lenders use to figure out how much to change the mortgage. The stability of your adjustable loan depends on how stable the index is. When you are shopping around, you should think about both the index and the margin.
Adjustment Period: The length of time that your interest rate will stay the same. You'll see ARM numbers like 5-1. This means that your mortgage interest stays the same for the first five years and then changes every year after that.
Interest Rate Caps: This is the most interest a lender can charge you.
Caps on how much your loan can go up during an adjustment period may be put in place by the lender. Not all ARMs have rates that can't go up.
Overall caps: Mortgage lenders may also put a limit on how much the interest rate can go up over the life of the loan. Since 1987, it has been against the law to wear an overall cap. Payment caps limit how much your monthly payment can go up with each change.
Negative amortisation: Most of the time, a portion of your payment goes toward paying down the principal and lowering your total debt. But if the payment isn't enough to cover even the interest, the unpaid amount is added back to the loan, making the total amount you owe on your mortgage loan go up. In short, if this keeps up, you may end up owing more than you had when you began.
Negative amortisation is a problem that could happen if the monthly payments aren't enough to cover the cost of interest.
Henry Moore said, "The important thing is to find out what works for you." Keep that in mind as you compare lenders, loans, and rates.
