For the past five years, almost everyone, including me, has proclaimed loudly that long-term fixed mortgage rates below4 percent were unsustainable, and anyone who could lock into such a rate should do so at once.
Well, Federal Reserve Chairman Ben Bernanke apparently has decided to heed my warning, and is making lots of noises about raising rates slowly over some indefinite period of time. In order to serve in that position, one learns to speak in nebulous phrases.
The bottom line is, the rate for long-term, fixed-interest rate loans has risen almost 100 basis points over the past 12 months. A basis point is 1/100th of a percentage point. As I write this, the best rate I can find for a 30-year fixed-rate loan is about 4.25 percent.
Let’s put all this into perspective:
• If you had borrowed $100,000 for 30 years at a fixed rate of 3.375 percent, your monthly payment of principal and interest would be about $442.
• In contrast, if you borrowed the same amount today for 30 years at 4.375 percent, your monthly principal and interest payment would be about $500, an increase of almost $58 every month.
• But to truly understand how good things still are, you need to compare all this to the same loan, if you had borrowed during 1982, when 30-year fixed-rate loans averaged just above 16 percent. Your monthly payment of principal and interest was just above $1,344, plus taxes and insurance. (I remember clearly, because I did, and mine was!)
So, let’s say you have been sitting on the fence and were sort of hoping interest rates would get down to zero or some other reasonable figure, and now you wish you had locked in at 3.375 percent.
All hope is not lost.
One way you can beat the system is to work with it. In other words, if you’re willing to take on some of the risk of higher interest rates in the years ahead, today’s lender is willing to reward you with a lower rate today.
One example of this is the 7/1 Adjustable Rate Mortgage, also called an ARM.
In this loan program, your loan rate is locked in today at an attractive rate for the first seven years, then your loan converts to a one-year adjustable for the remaining 23 years.
While the loan can adjust upward every year after the initial fixed period, there are limits on the size of any annual change as well as on the maximum lifetime change, so the loan does have some controls.
If I were thinking about buying a house today, I would seriously consider locking in a 7/1 ARM at a starting rate of 3.25 percent on a 30-year program. I understand the rate will likely go up starting in the eighth year, but two factors urge me to accept that possibility:
1. Over the first seven years, I have saved seven full percentage points in interest payments. That’s the difference between the 4.25 percent of a fixed rate versus the 3.25 for the initial 7 years of the 7/1 ARM. That’s a lot of money I can use for other things, and
2. There’s a better-than-average chance that I will be moving to a larger or smaller house in a different location, simply because that’s what happens to most people.
As always, I recommend that you shop and compare among different loan programs to find the one that suits you best. In addition, be sure to ask your accountant to help you analyze the financial impact of buying a home on your overall economic condition.
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