The 30-year, fixed-rate mortgage isn’t your only option. Here are 4 other types of loans to consider
- Adjustable rate mortgages, or ARMs, have lower initial rates and are currently popular
- Monthly payments on an interest-only mortgage are often lower than other loan payments
- Fixed-rate mortgages with time frames either longer or shorter than 30 years can be beneficial
A five- to 10-year adjustable rate mortgage can work for a first-time buyer who might outgrow a small NYC studio before the loan matures.
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For many years the 30-year, fixed-rate mortgage has been the go-to option for buyers but with rates currently more than double what they were a year ago, many are looking for alternative loan options.
To offset rising costs, many borrowers are protecting their credit score to get a lower rate and also moving funds to banks where they may be eligible for a rate discount. It's also possible to buy points to lower your rate but for many, seeking out a different mortgage product from the 30-year fixed has benefits.
This is especially the case in New York City, where the median sales price in Manhattan is close to $1,200,000, and even a slightly lower interest rate can make a meaningful difference in the monthly payment.
Instead of taking out a 30-year fixed mortgage, you might consider adjustable rate mortgages or ARMs, and interest-only mortgages, as well as fixed mortgages with time frames either longer or shorter than 30 years.
1) An adjustable rate mortgage or ARM
If you think you’ll move or pay off your mortgage in the next decade, a five-, seven-, or 10-year ARM may be a good choice. ARMs typically have lower initial interest rates and stay at that level for the duration of the ARM, then adjust based on the market every six months after that. Brian McNamara, a private mortgage banker at Wells Fargo, says this can work for a first-time buyer who might outgrow a small NYC studio or one bedroom before the ARM matures.
“If someone is buying a starter home and expects they will keep it for less than seven years, they may never go through an adjustment,” he says.
Currently, someone with good credit who puts 20 percent down can get an interest rate on a seven-year, non-conforming ARM from Wells Fargo that’s about 0.250 percent lower than what they could get with a 30-year, fixed-rate loan.
“On a $2 million loan, that would save them more than $300 in principal and interest payments each month and more than $3,600 every year during the initial seven-year period,” McNamara says.
You can refinance an ARM at any point without a prepayment penalty. You just have to read the paperwork and pay attention to the estimated increases.
When shopping around, the advice from Brittney Baldwin, vice president of National Cooperative Bank (a Brick Underground sponsor), is to contact a lender or two to see what products they may have available that will work for your situation.
"They will be able to show you the interest rates for the various product offerings that would meet your budget," she says.
It’s true these less predictable mortgages were toxic for owners during the 2008 financial crisis as rates spiked and payments became more difficult, but there are a lot more protections in place now for borrowers. Perhaps too many protections, argues mortgage broker Kevin Leibowitz, founder of Grayton Mortgage.
"Too many people are locked out of financing," he says, because there is such a focus on income. That means high-credit retirees and people who are self-employed but are otherwise grade A borrowers are struggling to get mortgages. "Are we serving the broader market if we are only loaning to the top of the heap?" Leibowitz asks.
2) An interest-only mortgage
An interest-only loan typically comes with a higher interest rate, but the monthly payment can be substantially lower than an amortizing loan payment.
As the name suggests, your monthly payments don't pay down the principal loan amount during the first 10 years. McNamara says this product can work for those who receive a significant portion of their income in an annual bonus or who have variable incomes and expect to receive larger sums in the future.
“The interest-only payments help customers match the monthly payment with their cash flow and if they want to pay down the balance during the interest-only period, they can do it when they receive a bonus or have a strong monthly income,” he says.
Banks are in the best position to offer the lowest rates to customers for interest-only mortgages as well as ARMs. That's because they can carry the debt whereas a mortgage broker or non-bank lender will sell on the mortgage and if they've offered a lower rate, below 6.5 percent, they'll make a loss. "Jumbos, interest-only and ARMs—the banks are beating all of the non-banks on these," Leibowitz says.
3) A 15-year mortgage
Another option is to shorten the life of the loan—paying more in a shorter space of time. Rates on 15-year mortgages are a bit lower than a 30-year fixed-rate mortgage, but your monthly payments will be higher. You pay less interest over the life of the loan, and your entire mortgage will be paid off after 15 years, but the tighter schedule increases your monthly payments.
This is a mortgage that works for someone who can afford the higher payments. In the current interest rate environment, loan officers say there's generally less interest in this type of product because most borrowers are doing what they can to reduce their monthly payments rather than increase them.
4) A 40-year mortgage
The 40-year mortgage is a relatively new type of loan and not all lenders offer them. You’ll have lower monthly payments because you’re paying the loan back over a longer period, but you also risk still having mortgage debt past retirement age.
These mortgages are portfolio loans, a type of non-conforming loan that’s a good option if you have bad credit, are self-employed, or need more flexibility.
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