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When does an Adjustable Rate Mortgage or a long-term Balloon make more sense?
A 30-year fixed rate loan is not always the best option. Chances are that you won’t live 30 years in your next home. You’ll either sell it or keep it as an investment. in which case, the chances of you wanting to keep the same mortgage without refinancing are very low:
The price of your peace-of-mind
The interest rate on a 30-year fixed – and therefore its monthly payments- is normally higher than an ARM or a Balloon Mortgage
- Purchasing power – The lower monthly payments of an ARM or a Balloon will help you buy a home that you couldn’t afford if you opted for a fixed-rate loan.
- Faster pay-down and savings - Applying towards the principal the difference between the two payments can help you accelerate the term of the loan and, thereby, result tremendous savings in interest payments.
- Changing terms - If you choose a 30-year fixed loan for peace of mind, but sell or refinance your home before the end of those 30 years, you’ll be paying needless extra interest and monthly payments.
Market rates and life-stages change
Interest rates fluctuate and, if you decided not to sell your home, there may be situations when, even a 30-year fixed should be refinanced, incurring you the expenses of a new interest rate and closing costs:
- Rates drop - If rates fell dramatically, and were lower than your 30-year loan’s, you’d refinance. On an ARM, when the initial term is over, your rate will lower automatically.
- Rates go up - If rates go up and the initial term of your ARM ends and it is time for the rate to adjust, you can evaluate if it’s time to sell the property, pay the 2% increase for one year, or refinance to keep the property for at least 5 more years.
- Cash out - Life circumstances may require you to use the equity you have built in your home to pay for your kids’ education, home improvements, down payment on a bigger house, debt consolidation, etc.
- More income - 15 years from now, it is highly probable that you will have a higher salary (or even dual income) giving you a much larger purchasing power than the one you had when you bought your first-home. At that point you could purchase a home more adequate to that stage in your life –and your means- or obtain a new loan with advantageous terms.
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5/1 ARM |
7/1 ARM |
15 BALLOON |
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Number of years the interest rate/monthly payment* will remain the same |
5 |
7 |
15 |
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Number of years the payments are calculated (amortization) |
30 |
30 |
30 |
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Number of years remaining with an adjusted interest rate** |
25 |
23 |
0 |
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Number of times the interest rate adjusts per year (could go up or down) |
1 |
1 |
1 |
*Monthly payments are applied toward the loan (interest and principal will remain the same), insurance and/or property taxes (may vary from year to year)
**Depends on the number of years you keep the property or the mortgage. After the introductory rate expires, the adjusted rate won’t be higher or lower than the market rate +/- 2% per year
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