Usually young couples are faced with an exciting time when they decide to buy a house. It is usually their first home purchase and the choice of the many beautiful houses just makes them more excited. This will soon turn into stress when they start looking at the financial dimension of this expensive purchase. Unless they inherited a large sum from their parents, they basically do not have any other choice than to find an affordable mortgage. Soon they will feel confused and apprehensive because they have to choose from the many types of mortgages. Which one is the best?
The first fact they discover is the existence of two types of mortgages: fixed rate mortgages and adjustable rate mortgages. The advantage of fixed rate mortagage is that the interest rate will not change throughout the life of the loan. The adjustable mortgage rate, in turn, works differently with its own peculiar advantages and disadvantages.
The most important advantage of adjustable mortgages is that the young couple mentioned will be able to get a lower interest rate compared to a fixed mortgage. This is an important incentive for many new homeowners because they usually just started their careers and do not have a lot of money to pay for relatively high interest rates.
However, the most important disadvantage of adjustable mortgages is that the interest may change and the monthly payments for the house may also change. The biggest worry is of course when the interest rate goes up. This might happen overnight with adjustable mortgages.
Despite the fact that there is cap to prevent the rates from fluctuating too much, a little fluctutation may be too much for some homeowners. This means that new and old homeowners taking an adjustable mortgage may not be able to plan their budgets. Then again, the adjustable mortgage gives this opportunity to pay less when interest drops resulting in lower monthly installments.
The young couple might choose the fixed mortgage over the adjustable mortgage if they can lower the interest rate. This can actually be done by purchasing points. It must be realized that this will certainly increase the upfront costs for the mortgage, but it might be worth it if the interest rates are high. But the adjustable mortgage if still very interesting due to its lower start up costs.
The most important thing to realize if an adjustable mortgage is chosen is to make a good financial forecast. Its is important to know how the interest rates might develop in the future. This must also be projected in the monthly payments. The next question is whether the young couple can afford fluctuations in their monthly budget to be able to pay increases if they happen in the (near) future. If a realistic financial forecast is impossible to make, a fixed mortgage might be the better option. In the end nobody wants to loose their homes if the interest rate might be going up unexpectedly.
This is in fact happening in the current US estate market. Tens on thousands of Americans are now starting to experience difficulties paying their monthly mortgages. 25% of all the mortgages in the US consists of adjustable mortgages. This means that around 10 million Americans may not be able to finance their homes anymore. According to the Mortgage Bankers Association, most of the adjustable mortgage holders have subpar credit ratings and this might be the start of a bad time for these homeowners.