Fixed-rate mortgages have been preferred the past few years following the housing bust because of their stability and certainty. However, adjustable-rate mortgages, with their low introductory interest rate, have been rebounding recently in loan the market.
In the past year, rate for the 30-year fixed mortgages climbed from about 3.4 percent in February 2013 to about 4.1 percent in February 2014. This upward trend will continue and likely reach 5 percent before the end of 2014, says Erin Lantz, director of the Zillow Mortgage Marketplace.
On the other hand, 5/1 ARMs still show near historical low introductory rates, around 2.75 percent in February 2014, which seems more appealing to homebuyers.
Particularly, for buyers plan to move or sell their houses within few years, hybrid ARMs could be financially advantageous, since they provide extended initial period with a fixed-rate from three to ten years, says Len Kiefer, deputy chief economist at Freddie Mac.
According to Freddie Mac’s ARM Annual Survey, in January 2014 the interest-rate savings for a 5/1 hybrid ARM with a 30-year term compared to the 30-year fixed-rate mortgage amounted to about 1.36 percentage points. On a $250,000 loan, this results in $194 in principal and interest savings during the first five years of the ARM loan versus a fixed-rate mortgage.
However, homebuyers should be wary of possible risk that interest rate can go up after fixed-rate period ends.
Interest rates will increase as Federal Reserve System begin to taper its quantitative easing as the economy continues to show signs of improvement, says Kiefer.
Moreover, if home prices drop unexpectedly, a buyer could wind up getting negative equity, lose its selling point and be stuck in a mortgage with a rate that adjusts higher, as experienced during housing bust, says Lantz.
As always, buy a house that you can comfortably afford. If a buyer qualifies for an ARM, consider one with longer fixed periods, such as 7/1 or 10/1 ARMs, which can give a leeway in case that circumstances change.
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