When you go to buy a home, you will learn that there are two kinds of mortgages: fixed-rate and adjustable-rate.
What’s the difference?
A fixed-rate mortgage gives you an interest rate that never changes. An adjustable-rate mortgage gives you a volatile interest rate: in times of slow economic growth and low inflation, the interest rate will be low; in times of high economic growth and inflation, the interest rate will rise.
Why do some people like adjustable-rate mortgages?
Advocates of adjustable-rate mortgages argue that these give you a shot at getting lower rates than you can ever get with a fixed-rate. In late 2010, when the average fixed-rate mortgage was 4.5 percent, I overheard a guy sitting at the table next to me at a sushi restaurant bragging to his dinner companions about his brand-new, adjustable-rate 3.25 percent mortgage.
It’s true that he’s getting a lower rate than those with fixed-rate mortgages … for now.
You can’t predict the future.
But what’s going to happen in 3 years, 5 years, even 10 years, when interest rates rise and this guy’s 3.25 percent rises to a whopping 6 percent or 7 percent?
Advocates for adjustable-rate mortgages argue two points:
1. You never know which type of mortgage will end up being cheaper in the end – why not keep open the possibility of a cheaper mortgage?
2. Paying 7 percent in 10 years … when you owes less on your mortgage … is better than paying 4.5 percent now, when you carry the heaviest loan on your mortgage. In other words, it’s better to owe a low interest rate on a big debt , and a high interest rate on a small debt.
No one lost their home because their monthly payment stayed the same.
To point #1: An adjustable-rate mortgage might be cheaper OR more expensive in the end — there’s no way to know. So why take on the added risk and uncertainty?
To point #2: Don’t assume that 5 years, 10 years, or 15 years down the road, when the rate on your mortgage rises, you’ll be in a position in which you’ll be able to handle the extra payments.
Let’s say you’re paying $700 a month on your mortgage right now. Four years down the road, you have a kid. Two years later you have another kid. The following year, your brother gets sick and you take one month off work, unpaid, to care of him. Then your furnace breaks down. Your car breaks down. A storm blows a heavy tree limb onto your roof, causing you to need a new roof. Gas prices have reached $5.50 a gallon. You discover you need eyeglasses. And – guess what? – now your interest rates have climbed, and your new mortgage bill is $1200 per month.
Can you afford it? More importantly — can you say, with absolute certainty, that you are SO SURE you’ll be able to afford any mortgage bill, no matter how high it climbs, at any time over the next 30 years, that you’re willing to take this incredible gamble …. knowing that if you lose this gamble, it will cost you your home?