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Over the past several months, I have been answering various questions from readers asking me about adjustable rate and fixed rate mortgages. Here's a quick menu of what rates you might find today with no points or origination fees:
- 30 Year Fixed Rate - 6.50 Percent
- 5/1 ARM - 5.25 Percent
- One Year ARM - 4.75 Percent
- Monthly LIBOR ARM - 3.75 Percent
Okay, now let's check out the monthly principal and interest (P&I) payments for a loan balance of $300,000.
- 6.50 Percent - $1,896
- 5.25 Percent - $1,656
- 4.75 Percent - $1,565
- 3.75 Percent - $1,389
Adjustable rates are lower rate because the risk of higher rates in the future is put upon the borrower. A borrower absorbs the risk but gets the benefit of a lower rate and payment. Take the difference between the fixed rate and the LIBOR ARM - $507 per month. Assuming the LIBOR remains at 3.75 percent for the next 12 months, the borrower saves $6,084. Not bad.
Now let's look at principal curtailment. At 6.50 percent, the $300,000 loan balance drops to $296,647 in 12 months - a gain of $3,353 in equity. At 3.75 percent, the balance drops to $294,484 - a gain of $5,516.
Not only is your payment lower by $507 per month, you also gain an additional $2,163 in equity.
Here's another example: Over five years, you would fork out $113,760 in mortgage payments if you take the 6.50 percent fixed rate. The 5/1 ARM, which is fixed for the first five years, would cost you $99,360 - $14,400 less.
After five years, the fixed rate would drop the mortgage balance to $280,833. The 5/1 ARM, at 5.25 percent, would drop the balance to $276,448 - an additional $4,385.
So the bottom line here folks, is that lower interest rates not only provide lower monthly payments, but also build equity faster. Don't get me wrong - fixed rates are very attractive and a great option for anyone thinking of holding the loan for a very long time. But if you think you might sell in a few years, get a good loan officer to present you with a menu of adjustables. It certainly can't hurt to know what's available.
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