This completely depends on how long you think you’ll be in your home.
If you believe you’ll be in your home less than 5 years, a Variable-Rate mortgage can make sense.
In this video, we model the difference from a cash-flow and net-worth perspective of Brenda and Kevin, our fictional couple from my book Strategic Money Planning: 8 Ways To Get Your Financial House In Order.
Brenda and Kevin started out with a fixed rate mortgage when they bought their first home, a starter home.
Times change, though, and a few years later, a job offer in a different state had them considering moving.
Only drawback was they had to sell their home.
Unfortunately, the real estate market turned against them (remember 2008?) and they were upside down on their mortgage. Being upside down means they owed more than the house was worth.
If they would have had cash available they might have been able to pay off the remaining balance from the sales price they were offering.
But because cash flow was so tight, they were unable to save and were unable to sell their home. Thus they had to decline the excellent job offer because they were stuck.
In hindsight, one of the reasons they had no cash available was because they took a higher interest, fixed-rate mortgage without considering what their future circumstances would be.
If they would have thought it through when they bought the house, they might have realized the likelihood of staying in their starter home for any significant time was probably quite low and planned accordingly.
A variable rate mortgage MAY have lowered their monthly payments AND reduced their principal mortgage balance at the same time, which I show in the video.
We use the Navy Federal Credit Union interest rates from August 2007 where a 3/1 ARM had an interest rate of 1.875% and a 30 year fixed mortgage had an interest rate of 3.75%.
We show the difference in payments and principal balances after 5 years with three scenarios: The Fixed Rate Mortgage scenario. The 3/1 year ARM with “good luck”, meaning the interest rate stayed at 1.875% for the entire 5 years.
The third scenario is the “bad luck” scenario, where the ARM rate was 1.875% the first three years, then went up to 3.875% in year four and to 5.875% in year five.
Now, you must always remember, with an ARM, typically the interest rate can increase by 6% in total over the course of the loan.
So, in the scenario I model, in year 6 the interest rate could have gone up to 7.85% where it would max out.
But, because 5 years is our rule of thumb for whether or not you should consider an ARM, I do not model the cost of the interest in year 6 for Brenda and Kevin.
The risk, of course, is what if you took an ARM thinking you’d sell your house within 5 years and it turns out you won’t?
In the example I use, you could be stuck with a 7.875% loan for the remaining 24 years of the mortgage!
So, BE CAREFUL! You don’t want to be stuck with a 7.875% mortgage when you could have locked in a fixed at 3.75% for 30 years!
Like all good financial planning, some thought and educated guesses are required.
What is truly the likelihood of moving within 5 years? Don’t just get caught up in the lower, initial, interest rate of an ARM if you really don’t think you’ll be moving.
On the other hand, don’t be ultra-conservative either with a fixed-rate mortgage, if you truly think there is a decent chance you’ll relocate.
Think this through!
Hopefully, this video can help you with that.
Here is the Navy Federal website for up-to-date mortgage rates. https://www.navyfederal.org/products-services/loans/mortgage/mortgage-rates.php
As you can see they have gone up a bit since. It’s important to keep track of rates if you are looking at mortgages, now and in the future.
If you like what you see, a thumbs up helps A LOT. So, give me a thumbs up, please!
Don’t forget to SUBSCRIBE by clicking here: https://www.youtube.com/channel/UCSEz…
GET MY BOOK:
Strategic Money Planning: 8 Easy Ways To Put Your House In Order
It’s FREE if you’re a Kindle Unlimited Subscriber!
GET ALL MY LATEST BLOGPOSTS:
Google +: https://plus.google.com/u/1/108893802…
Heritage Wealth Planning : Fixed or Variable Mortgage: The ONE Thing To Know (2018)