Adjustable vs fixed rate mortgages: Which makes more sense in NYC?
The buying process is nothing if not full of unexpected challenges and decisions. Beyond the initial hurdle of qualifying for a mortgage in the first place, if you're buying an apartment for the first time, you'll also want to consider which type of mortgage is best suited to your needs.
While most of us are familiar with the standard 30-year fixed-rate mortgage, there are other options to consider, many of which are better suited to younger buyers who may not plan on hanging on to a property for too long. "I always tell everyone that there's no perfect loan, it depends on your personal situation," says Ace Watansuparp of Citizens Bank, who starts by asking these questions: How long do you plan on living there? Do you want to sell it, or keep it as an investment property for later on?"
Below, a breakdown of the two major types of mortgages, and the pros and cons of each:
The adjustable-rate mortgage
Adjustable-rate mortgages—also known as ARMs—are exactly what they sound like: mortgages where, instead of having a fixed-rate for the entire length of your borrowing term, your interest rate may fluctuate after a set period of time. While this may bring more uncertainty than many buyers would like, it can mean lower monthly bills, more flexibility on payments, and a better deal if you plan on selling the apartment within a few years of buying.
"We have five-year, seven-year, and 10-year ARMs," explains Watanasuparp. "Though the mortgage is amortized over a 30-year period, the rate is only fixed for that first five, seven, or 10 years." After that, your rate could be subject to increases, which could dramatically change the size of your monthly payments. For this reason, an ARM works best for a buyer who knows they'll be re-selling the apartment before the end of that initial fixed-rate period.
"This is a good option for a borrower who does not see themselves in the property for longer than the adjustable rate term," says Robbie Gendels of National Cooperative Bank (FYI, a Brick sponsor).
On the flip side, you could find yourself stuck with a new, higher rate if circumstances change and you find yourself unable to sell. "You really have to be positive that you're going to move," says Watanasuparp.
Another factor to consider is the flexibility of the mortgage principal. For a fixed-rate mortgage, even if you pay more than your monthly minimum and shrink the total principal of your loan, your monthlies will stay the same. For an ARM, however, if the total amount you owe shrinks by a significant amount, your minimum monthly payments will go down accordingly, a potentially enticing option for buyers with uneven income, or who receive annual bonuses.
"If you're a Wall Street person with a $1 million mortgage, and at the end of the year when you get your bonus, you pay $100,000 toward that mortgage, then your loan becomes $900,000, and the payment gets re-calculated by the new loan amount," explains Watanasuparp. "On a 30-year fixed mortgage, [that kind of contribution] lowers the total amount of time that you're obligated to pay down the mortgage, but it will never lower the payment amount."
In short, an adjustable-rate mortgage offers flexibility and low monthlies for a first-time buyer who's hoping to flip or re-sell their property within five, seven, or 10 years. But as a longer-term strategy, it can be risky.
The fixed-rate mortgage
Though you can find fixed-rate options for anywhere from 10 years to even 50 years, the most common options are the 15- and 30-year versions.
For these, the pros and cons are pretty straightforward: A 30-year fixed-rate loan will keep your monthly mortgage payments low and reliable, but over decades, you'll be paying a much higher amount in interest. "The 30-year's main benefit of course is that the monthly payment is lower, and that's probably why it's the most popular loan out there," says Watanasuparp. "But if you do utilize all 30 years, you're going to pay interest a lot larger than the loan amount itself—you could pay double of the principal of the loan by the end of it."
Blanton also points out that the interest rates for 30-year fixed rates tend to be higher, whereas a 15-year loan could net you a lower interest rate. "A shorter term loan such as a 15-year mortgage will typically return a lower interest rate," she says. "However, due to the shorter term, it will also have a higher monthly payment."
Unsurprisingly, since a 15-year loan involves paying off your mortgage twice as fast as you would a 30-year, you can expect your monthly payments to be nearly double. "You're paying off the loan a lot quicker, but you have to make sure that you'll be able to sustain your monthly obligations, and that this isn't something that will put a strain on your monthly cash flow," says Watanasuparp.
Ultimately, the kind of mortgage you choose will depend on how long you plan on owning the property, the nature (and schedule) of your income, and your tolerance for both risk and interest payments. And of course, whatever you choose, there's always the option to refinance down the road (you can play around with potential savings and options using a calculator like this one from NerdWallet). But you might not necessarily want to count on it: If your income changes or your credit score takes a significant hit, by the time it comes time to refinance, you could find it difficult to get that new loan you expected. And on top of that, rates may have changed.
"Most people re-finance to lower their rate or lower the length of time of the mortgage," says Watanasuparp. "Buyers can re-finance at any point, and they need to be thinking about what rates will be." Especially with rates on the rise at the moment, if you're taking out an ARM with the intention of re-financing at the end of it, you may find yourself eager to re-finance sooner than expected.
In any case, be sure to carefully assess the options with both your real estate agent and mortgage broker before making a final decision—after all, what kind of loan you choose will affect your monthly bills for years to come.
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