Fixed versus Adjustable Rate Mortgages
With the success of the Colin Bibra finance clinics over the past year comes the flurry of questions these clinics bring. I am inundated daily with clients looking to understand and navigate the complex and confusing world of property finance, whether for personal property or as an investment. So, I have decided to take on these topics in my weekly column.
This week, I would like to talk fixed versus adjustable rate mortgages – a popular topic of enquiry at our financing seminars. This is generating even more conversation since last month’s announcement by Lloyds that it had set aside over £6bn for lending to first-time buyers. Coupled with the government’s Funding for Lending scheme, this means that fixed-rate mortgage rates will come down further, becoming more competitive with ARMs and giving buyers and re-mortgagers more and better choices.
Fixed rate mortgages are simple: you have a fixed interest rate for the life of your loan (up to 30 years). Adjustable rate mortgages are more complex and there are a variety of terms offered among lenders. Basically, ARMs start out with a low interest rate (some as low as 1.99%) and look incredibly attractive at first glance because of this. Unfortunately, after the initial term (between two and three years), the rate jumps drastically – to around 4% and more, and thereafter periodically adjust to some predefined index, all set forth in the mortgage contract.
ARMs are attractive, especially to new buyers, because the initial rate is set below that of a fixed-rate loan. They can afford – at least initially – a larger loan due to low payments. However, the adjustable rate means that holding onto the property for the life of the loan often means that the interest rate on your mortgage will eventually exceed that for a fixed-term loan.
Buyers need to weigh the pros and cons of each mortgage type along with their goals and plans, the long-term market outlook, and their financial abilities – both current and prospective.