Everyone must be aware of rising interest rates and fear it will continue going up based on the Federal Reserve’s recent action and an improving economy. We’ve written about the impact, and our belief home buyers shouldn’t be overly concerned. Nonetheless, there are viable financing options that prospective buyers can consider.
Most home buyers choose the comfort of a fixed rate for 30 years, the most popular option, although there are other choices, including the 15-year term. However, hybrid options might be worth checking out. This offers a fixed rate for a period and then becomes an adjustable mortgage. As a reminder, the other options are a fixed rate mortgage in which the lender cannot raise the interest rate, or an adjustable rate mortgage, which fluctuates based on a short-term benchmark such as one year Treasuries or LIBOR. This blog provides an outline of the basics of mortgages.
A hybrid might be appropriate if you only plan to own the home a few years. This is typical for first-time buyers. For the fixed period, the interest rate will be lower than a thirty-year mortgage. Examining data obtained from online sources, fixed-rate mortgages in the New York City area is around the national average of 4.5% to 4.75%. On a $500,000 mortgage, the monthly payment is $2,533.43, assuming the low end of the range.
However, a 5/1 ARM is 3.05%. On the same $500,000 mortgage, the payment is $2,121.53, a monthly savings of about $400.
Hybrids are quoted with the length of time for the fixed rate, followed by how frequently it is then adjusted. A 5/1 ARM means the rate will be fixed for five years and then will be adjusted annually. Other popular options are a 3/1 ARM, 7/1 ARM, 10/1 ARM.
The approach is not without risks. Homeowners may end up staying longer in the home for a variety of reasons, such as changing financial or personal circumstances. This means the interest rate could spike upwards at the end of the fixed rate period, especially if short-term rates are not at these rock-bottom levels. Alternatively, the housing market could be vastly different, and it may be difficult to sell when you are ready, at which point your payment could go up.
Mortgage rates may not be as attractive when you are ready to move up to a larger place, another point to consider.
A hybrid is not for everyone. However, it is another option for prospective buyers. Depending on your circumstances and risk tolerance, it might be an attractive option. As we’ve learned from the housing bubble and burst, it pays to be fully informed regarding financing options.