Today’s economy has many hopeful buyers looking for a way to save on their mortgage.
However, the classic option may still be the best for many of us.
As mortgage rates remain near 7%, alternative mortgages such as adjustable rate loans and shorter term mortgages are gaining popularity. However, after research and discussions with experts, the benefits of these loans do not outweigh the costs, and the traditional fixed rate mortgage remains the best option for us.
The beauty of a fixed rate mortgage is that it provides certainty in an uncertain world. With a fixed rate, your interest rate won’t change and you’ll always have the same monthly payment, no matter how rates change in the future.
Why we avoid alternative mortgage types
Some buyers want – or need – their monthly mortgage payment to be as low as possible, regardless of long-term costs. However, we are fortunate to be in a situation that allows us to be picky and alternative mortgages just aren’t worth it for us.
The most common type of alternative mortgage is the adjustable rate mortgage (ARM), which is especially attractive when interest rates are higher. ARMs still make up only 7% of all mortgages, but that rate has doubled over the past two years as interest rates have risen.
With an ARM, you receive a lower rate for a set number of years at the start of the loan, and then the interest rate typically adjusts once or twice a year, depending on the current rate. The upside is lower payments upfront and potentially later if rates fall, but the downside is a higher monthly payment if rates rise.
An ARM might be a good option if you know you’ll sell the home before variable rates take effect. That was the recommendation of Sarah Alvarez, vice president of mortgage banking at William Raveis Mortgage, to someone planning to live in a home for five years. or six years.
“In this scenario, I would highly recommend considering a 7-year adjustable product,” Alvarez told Business Insider. “You’re incentivized by a lower rate and you’ll pay off the mortgage before the rate leaves its fixed period. In this high-rate market, it’s best to focus on keeping monthly payments low.”
As both of our daughters will be entering high school in the next two years, there is a good chance we will look to relocate or relocate within the next seven or eight years, but this is not guaranteed and may depend on the state of the real estate market at that time. .
Austin, the author’s home. Brandon Bell/Getty Images
Another problem with the ARM is that mortgage interest rates generally follow Treasury rates, with 30-year fixed-rate mortgages following the 10-year Treasury yield and ARMs starting rate following rates. shorter notes like those for 1 year. Treasury.
Currently, rates on short-term Treasury bills are higher than rates on long-term bonds, a phenomenon known as an inverted yield curve. This means that an ARM’s introductory interest rate based on these short-term Treasury rates might be little better than more predictable fixed-rate loans that depend on long-term rates.
And in some cases, the ARM interest rate may be higher. According to Optimal Blue, a mortgage data company, via the Wall Street Journal, the average initial rate for an ARM with a fixed first five years was 7.04% as of December. The average rate for a 30-year fixed-rate mortgage that month was 6.86%.
Interest-only mortgages seem too expensive and too risky
Another form of home financing that is growing in popularity is the interest-only mortgage.
With an interest-only mortgage, the buyer does not pay a monthly amount toward the principal of the loan at the beginning of the loan term, but only pays the monthly interest.
Although the initial monthly payments are much lower, the principal is not repaid, so the homeowner only gains equity through changes in the value of the initial down payment amount and not by reducing the amount that the bank can claim, with greater risk. to lose equity if home values fall.
Additionally, the borrower adds a considerable amount to the total cost of the home in the form of interest paid over time.
Buying discount points is popular but may not be worth it
Another common way to lower mortgage payments is to use “discount points,” in which the buyer pays a lender at closing to reduce the interest rate, with the point equal to 1% of the loan amount and each point generally lowering the rate by 0.25%. . But it turns out that even these are often not worth the cost.
According to Freddie Mac, 59% of borrowers used points to lower their interest rate in 2023, compared to 31% in 2021. And yet, according to their research, the average interest rate in 2023 for those who purchased points was 6.61% in 2023, only slightly better than the average rate of 6.69% for those who did not purchase points.
This shows that the pre-forgiveness rate was higher for people who purchased points and could indicate that lenders view buyers looking to lower their monthly payments as riskier.
Purchasing points from a lender can be more expensive in the long run. FG Commerce/Getty
If you get a lower rate by purchasing points, this may only be beneficial if you plan to stay in the home for a long time, long enough to save more money in interest than the amount spent to lower the rate . However, according to the National Association of Realtors, the typical homeowner only stays in their home for eight years.
We may have only owned our new home for less than 10 years, so buying discount points could cost us more on our next mortgage.
After all, sticking to the 30-year fixed rate
Although there is no risk of rates rising, there are ways to reduce your monthly mortgage payment with a fixed rate loan.
In our case, we will likely be able to put down a higher percentage than when we purchased our first home and interest rates were much less of a concern.
We can also choose to opt for a 30-year loan initially and then refinance to our preferred 15-year mortgage later. This way we can get a lower monthly payment up front without putting too much of a dent in the interest we would have to pay overall.
The other option for those looking to buy a home is to wait and hope that interest rates drop. However, this is also risky as property prices have remained stable and even continue to rise in some areas. Any gain someone might get with a lower interest rate could be offset by paying more for the house.
Although there are alternatives available for homebuyers looking to lower their monthly mortgage payments. However, these benefits are often minimal and end up costing more overall. So we’ll stick with a fixed rate mortgage and shop around for the best rate.
Have you used another type of mortgage to buy a home in recent years? Contact this journalist at cgaines@businessinsider.com.
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