This is one of the questions most first time buyers ask but perhaps they’re really not sure why one might be better than the other. Mortgage lenders offer a variety of loan programs from government-backed loans such as USDA, VA and FHA loans to conventional mortgages underwritten to guidelines set forth by Freddie Mac and Fannie Mae. Beyond these options, you’ll also need to decide between a fixed rate loan or an adjustable rate mortgage, or an ARM. So, if you’re a first-time buyer, which is better? The lender really doesn’t care which you choose yet there times when you should in fact select one over the other.
A fixed rate loan is fairly simple, really. It’s a loan where the interest rate never changes. It’s fixed and it’s something you can plan on throughout the life of the loan. Lenders offer fixed rate terms as low as 10 years but also in five-year increments up to 30 years including 15, 20 and 25-year terms.
The difference between the different loan terms resides in the monthly payment and the amount of interest paid. The longer the loan term the lower the monthly payment because the amount borrowed is stretched out over a longer period. The monthly payment for a 15-year loan is higher than a 30-year term even though the loan amount is exactly the same. Take a $250,000 loan to purchase a home in Jacksonville, Florida. If a 30-year rate is 4.25% the principal and interest payment is $1,229 compared to a 15-year rate of 4.00% payment of $1,479. Even though the interest rate on the 15-year loan will be lower than the 30-year term the payment is much higher.
On the flip side, the 30-year term while having the lower monthly payment the overall amount of interest paid to the lender is much greater compared to a 15-year term and even more so compared to a 10-year term.
Fixed rate loans provide stability and if you intend to buy and keep the property for any length of time say longer than five years or more then you might consider a fixed rate product.
Today most ARM programs come in the form of a hybrid. A hybrid loan is a mortgage program where the start rate is fixed for a predetermined period of time before changing into a loan where the rate can adjust once per year. A 3/1 hybrid for example has a start rate fixed for three years before turning into an adjustable rate mortgage. Hybrids can also be found in the form of 5/1, 7/1 and 10/1 options.
Once the hybrid adjusts the new rate for the following year is figured by taking the assigned index, such as a 1-year Treasury and adding a margin. ARMs also have interest rate caps which limit how much the rate can move between adjustments. Hybrids will have lower start rates compared to fixed rates of a similar term. This is why choosing a hybrid over a fixed if the borrowers don’t intend to live in the property for the long haul and expect to sell or otherwise retire the mortgage before or around the first adjustment. Or, for those who aren’t sure or simply don’t like the uncertainty of an ARM regardless of longer term intentions, a fixed rate choice will provide a level of peace of mind and will never change. You can expect your loan officer to ask how long you intend to keep the mortgage and this is the reason why- whether to suggest fixed or ARM options for you to consider.
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