Adjustable vs Fixed Rate Mortgages – Which is right for you?

You’re shopping for a house.  You’ve done your homework researching rates, terms, different lenders, etc.  But, did you look at different loan options as well?  How do you decide if a fixed rate or adjustable rate mortgage is right for you?   There are pros and cons to both fixed rate mortgages and adjustable rate mortgages (ARMs).  The loan that makes the most sense for you will depend on your preferences, financial standing, and future plans.

First let’s look at the difference between fixed and adjustable rate mortgages.  Fixed rate mortgages have an interest rate, and therefore a monthly principal and interest (P&I) payment, that remains the same over the life of the loan.  An adjustable rate mortgage, as the name suggests, means that the interest rate can fluctuate over the life of the loan, according to the variables laid out in your original loan agreement.  (For details on understanding adjustable rate mortgages, refer to this post). With both loan types, you can generally choose a term that fits your needs – 10, 15, 20, 30 years.  Assuming that you’d be shopping for a loan term of 30 years, here are some factors to consider.

1.       How long do you plan to stay in your home (or mortgage loan)?  

Many people do not plan to stay in their homes or mortgages long enough to make a fixed rate loan worthwhile.  On average, homeowners move every 8-10 years and refinance their mortgage even more often than that.  If this sounds like you, you may want to consider an adjustable rate mortgage over a fixed rate mortgage.  Rates on fixed rate mortgages tend to be somewhat higher than the initial rate on adjustable rate mortgages.  This is because when the loan is written the lender assumes that you will take the full 30 year term to pay the loan back.  If rates go up over the lifetime of the loan, the lender may end up losing money.  If you do not plan to stay in your home long enough to see the interest rate change on your adjustable rate mortgage, if you expect to refinance your loan in 5 to 10 years, or if you can afford a slight increase in your P&I payment for a year or two before you move, why pay extra interest up front for the reassurance of a fixed rate loan you’re not going to keep long enough to enjoy? 

2.       What are the trends with interest rates? 

If you expect rates to increase over the term of your loan, then it may make sense to lock in a low fixed rate today.  However, if you if you opt for the fixed rate and interest rates later fall, you will have to refinance in order to lower the rate on your mortgage, paying closing costs all over again.  An adjustable rate mortgage, on the other hand, allows your interest rate to adjust to the market, so if rates stay low or drop, the same could happen to the rate on your mortgage without the hassle of refinancing.  Many people worry that if they opt for an adjustable rate mortgage and rates increase, they will start out paying 3% and end up paying 20%.  In reality, if you choose a good adjustable rate mortgage, you do have some protection.  Your ARM will come with rate caps, both for each adjustment and for the lifetime of the loan, to prevent sudden, astronomical rate hikes.   This ties into the first point as well, since the longer you plan to stay in your home, the more uncertainty there is in predicting interest rates. 

3.       How do you budget?  

If your monthly housing budget is very tight and you would not be able to afford even a small increase to your monthly principal and interest payment, the fixed rate loan probably makes more sense even if it will cost you a bit more or you do not plan to stay in the home for a full 30 years.  However, you should consider that a fully escrowed payment on a fixed rate loan could still change.  The P&I payment will remain the same, but varying tax and insurance costs over the time you own your home can still lead to changes in your total monthly payment.  Conversely, if you can budget for changes in your principal and interest payment then the up-front savings of an ARM may make up for payment increases down the road, especially if you use the initial savings to pay down the loan faster.  Each adjustment to the payment is calculated based on the remaining principal loan balance at that time, rather than the initial amount borrowed.  So if you pay your loan down ahead of schedule, you could end up enjoying decreasing monthly payments even if your interest rate increases slightly!

4.       How much flexibility do you want or expect? 

Most fixed rate loans are sold to the secondary market, meaning that while you might get your loan at XYZ Credit Union or ABC Bank, it will probably ultimately end up being owned and serviced by Fannie Mae or Freddie Mac.  This results in essentially a “standard” fixed rate loan that varies very little from one financial institution to another; whereas institutions often retain adjustable rate mortgages on their own books.  This allows for greater flexibility and customization of adjustable rate mortgages.  Even something as simple as splitting your mortgage payment into two bi-weekly payments in order to reduce the amount of interest you pay can be difficult (or cost money) when your loan is sold to the secondary market.

The loan type that is right for you is going to be totally subjective and will depend a lot on how you expect the future to play out.  The most important thing you can do in shopping for a mortgage loan is get the facts straight.  Make sure that you understand all the terms you’re being quoted, and what they actually mean in regard to how your loan will behave. 

As final food for thought, here is a scenario that was put together by Freddie Mac to compare the costs of fixed rate loans versus adjustable rate loans:

In January 2003 the average fixed rate mortgage came in at 5.92%.  For a loan of $200,000 the principal and interest payments for 10 years would have cost you $142,660.  However, an ARM that adjusted annually had an initial rate of 3.99%.  Even after recalculating the interest rate each year, the total amount paid in principal and interest for that same loan and time period came to only $119,181 – a savings of over $23,000!  The adjustments on the ARM loan did increase the rate to 5.47% at its peak, but that is still lower than the 5.92% you would have paid on the fixed rate loan.  And, at one point the ARM rate fell to 2.76%.       

Stop Saying and Start Doing!

If you’re one of the many people who struggle with procrastination, then this post is for you. It’s so easy to say you’re going to do something, it’s the actual doing it part that’s challenging. So how can we stop saying and start doing?

Stop Assuming. When we procrastinate, we assume something can get done at a later time. We assume the timing will be better. We assume we’ll have more motivation. We assume we’ll have another opportunity to get it done. But do you really want to bet on your assumptions? Stuff comes up and just because you have a good plan doesn’t guarantee a thing. What is guaranteed is that right now you have the opportunity. If we stop assuming we’ll have another chance to get something done, we’re more likely to do it now.

List Your Excuses. You have some really valid reasons for procrastinating, right? Well, write them down then. Listing why you’re not going to do something can force you to evaluate whether or not your reasons are just excuses or legitimate justifications. If your reason for not doing something is that you’re just generally busy or tired, that’s an excuse. If your reason is that you have to leave for work in ten minutes, that’s a legitimate justification.

Make a Date. This might seem counter-intuitive to stop procrastinating because it means planning to do something at a later time. But sometimes you really do have a legitimate justification for not doing something right away. In that case, you need to choose a specific day and time that you are going to do it. Write it in your calendar, program a reminder in your phone, and don’t make any other commitments for that time. It’s harder to procrastinate when you’ve given yourself a set time to complete that task.

Written by: Noelle C.

Four Financial Moves Every College Grad Must Make ASAP

Tis the season—there are graduations almost every weekend! For those who’ve just graduated college, the future may seem a bit frightening. Don't worry-- Suze Orman has some solid advice. If her name sounds familiar, it should. Suze Orman is considered a “force in the world of personal finance,” and her advice is trusted by many. Here’s some of the advice she has for college graduates:

1. Get On Top of Your Student Loans: Yes, you have a six-month grace period before repayment of federal loans must begin. Don’t you dare wait five months and three weeks before focusing on this. Screw up on repayment is one of the most damaging mistakes you can ever make, and it becomes both hard and expensive to get on track if you fall behind. 

2. Make Sure You Have Health Insurance: If you haven’t yet started a job with benefits, or you’re taking a gap year, please don’t go naked here. Yes, the odds are low you might get sick, but insurance is about protecting yourself from the big “what ifs.” Besides, it’s not just about illness; any type of injury can set you back, from a broken bone to a torn ACL. If your parents have health insurance from an employer they should be able to carry you on that policy until you are 26, for a cost. Ask them to find out the cost, then compare it to what you can purchase for yourself (Go to healthcare.gov). If you and your parents decide it’s best to go with their plan, and you have a paying job, you should pay your share of their premium, or at the very least contribute. You’re their kid, but you are also an adult now. 

3. Get a Credit Card…if You Don’t Already Have One: As much as I applaud using just a debit card—paying as you go, rather than being tempted to overspend with a credit card—it still is important to have a credit card as well. The goal is to use it just a few times each month—for small purchases. And then pay your bill, in full, each month. Doing that is going to go a long way in establishing a solid credit score.
Automate Savings ASAP. Okay, you know how I feel about the emergency fund. And you know how I feel about saving for retirement. Both are non-negotiable Must Do’s—and the sooner the smarter. I respect you may not have a big income just yet. But please listen to me: that’s not an excuse for doing nothing. You need to do something—save something—every month.

Emergency Savings: Set up an automatic monthly transfer (it should be free) from your checking account into a separate savings account. How much? Well, how much feels right? Then add 10% to that number. That’s my challenge. Just try it for six months. I think you will surprise yourself at how doable it is, and how powerful it feels to start building an emergency savings account. 

Retirement Savings: If you are offered a workplace retirement plan that comes with a company matching contribution, you better grab it. Be sure to confirm that you are contributing enough to qualify for the maximum match from your boss. It’s sad, but many companies set the “default” contribution rate for new employees at such a low level that the employee doesn’t get all the matching contribution they are entitled to. Don’t make that mistake!

If you don’t have a retirement plan through work, or the plan doesn’t offer a match, the best first-step for new grads is to start saving via a Roth IRA. Again, you can set up a monthly transfer from a checking account into a Roth IRA investment account. Some discount brokerages, such as TDAmeritrade don’t have a high minimum initial investment, so you can get started transferring say $100 or so a month into a Roth IRA.



We can help you here at Horizon Community Credit Union-don’t hesitate to call! An MSR can help you with savings accounts, automatic transfers, or IRA's.  You can also talk to a loan officer about a credit card!

Post by: Breanna B.

Road Trip!

Road trips are inevitable. At some point or another, we all have to take them. So might as well make the most of them! With a little preparation, you can make your road trip go by faster and more smoothly. Here’s what I do to before taking a road trip:

1. Review the route. I’m a big fan of Google Maps, and because I’m so directionally challenged, I’ll end up relying on it completely. But I do try to actually look over the route before I start the trip so that I have a basic idea of where I’m going and what major highways I have to take. That way if Google Maps fails me, I’m not totally lost.

2. Come up with a great playlist. Depending on how long the trip is, you might have to come up with several playlists. But it’s totally worth the time it takes to set them up. Listening to the radio on a long car trip means you’re probably going to end up endlessly changing radio channels or listening to the same ten songs that play over and over again. Having great new music you’re excited to listen to or having songs you know by heart can make the trip go by a lot faster.

3. Bring snacks. We all know how tempting it is to buy all sorts of snacks and junk food when you stop to get gas. Not only is this expensive, it also adds time to your trip. If you’re really pressed for time, searching the aisles is not going to help. Instead, plan to pack some snacks with you. Nuts are great because they take a while to eat, and they fill you up. You can even bring a small cooler to keep drinks cold.

4. Plan your stops. When figuring out how long the trip is going to take, make sure to take all your stops into consideration. If you know when and where you’re going to take stops, you’re less likely to make unnecessary stops or waste time finding a good place to stop. If you have the time, consider making a stop at a park. It feels great to walk around and get some fresh air. And you never know when you might be driving that way again, so take advantage of any local landmark or famous restaurants. Leave home a little bit earlier and make the trip more memorable.

Image courtesy of digitalart at FreeDigitalPhotos.net

Post by: Noelle C.