Mortgage interest rates are ratcheting quickly upward and already have reached 9 percent in several cities.
The outlook may be for worse to come. Wall Street had expected the Federal Reserve to raise short-term interest rates again last week, and that had spooked the bond market, to which mortgage rates are linked. The rate boost didn't materialize, but analysts predict another increase after the November elections.Even so, if you're buying a house and are pretty sure you'll be in it for many years to come, you'll probably want to get a 30-year fixed rate mortgage, even though it carries the highest interest rate.
You know what your monthly payments will be and can confidently plan a budget. No scary increases in rates that outpace the raises you get at work.
But many people, especially first-time homebuyers, won't stay in a house for even 10 years. Job transfers, a growing family, dissatisfaction with the neighborhood, a substantial growth in income - all these are reasons that people move on or up.
If you don't expect to stay in a house too long, there's no need to pay top dollar for a 30-year mortgage. Happily, the market now offers a number of less expensive alternatives.
Here are some examples:
- A 10-year balloon or ARM, which generally carries an interest rate half a point or more below the 30-year. Ten-year ARMS are averaging about 8.3 percent right now, according to HSH Associates, a mortgage information firm. These mortgages are amortized over 30 years, so your payments aren't any higher than on a 30-year mortgage. But at the end of 10 years, the mortgage ends or turns into a one-year ARM, depending on what type you get. If it's a balloon, you must pay off the balance at that time, either by selling the house, refinancing or with cash.
Ten years is a long, long time. How many of your friends and neighbors have been in one place for 10 years? How about you?
If you're pretty sure you'll be moving on within 10 years, there's no reason to get a mortgage with a longer term.
On a $125,000 loan, the monthly payments with a 30-year fixed rate mortgage at 9 percent would be $1,006. With a 10-year mortgage at 8.3 percent, payments fall to $946, a difference of $60 a month. Over 10 years, that's a savings of $7,200.
- A 15-year mortgage. This loan gets paid off in 15 years so the monthly payments are substantially higher than on a 30-year or a 10-year mortgage. But the interest rate is generally half a point or more below the 30-year rate.
For example, if you borrowed $125,000 with a 15-year mortgage at 8.4 percent, payments would be $1,225 or $219 a month more than on a 30-year mortgage at 9 percent.
Over 15 years, you would pay $39,420 more on the 15-year than on the 30-year mortgage. But you would then own the house free and clear instead of facing another 15 years of payments.
- Seven- or five-year two-steps, ARMS and balloons. These are much cheaper than 30-year mortgages. This week, according to the Mortgage Bankers Association, rates on the 7-year are averaging 8 percent and on the 5-year 7.8 percent. Together these types of loans account for about 4 percent of the business that mortgage brokers do.
The 7- and 5-year mortgages amortize over 30 years, but after the initial period the rate changes either to a new fixed rate or to a one-year ARM. There also are 5- and 7-year balloons that end after the initial period with a balance remaining. If you get a 5- or 7-year mortgage, be sure to ask what happens after the initial period.
- Three-year ARMS, which adjust every three years instead of one, are safer but cost more - right now, about 7.1 percent. Some lenders also offer 3/1 ARMs that turn into one-year adjustables after the first three years.
- One-year adjustable mortgages are the cheapest of all but also the most risky in today's climate of rising rates. You can get a one-year ARM at 5.8 percent, but by next year you'll be paying 7.8 percent and probably more in the third year. If you can barely afford payments at 5.8 percent, it's not wise to get an ARM that is sure to adjust upward in a year.
On the other hand, if you know you will be able to handle higher payments later, you'll save a lot of money with an ARM in the first two years. On a $125,000 mortgage, payments on a 5.8 percent mortgage are just $733 - a hefty $273 a month less than you would pay with a 9 percent mortgage.
Homeowners who stuck with ARMs in the 1980s generally came out ahead of those with fixed rate mortgages. But the '80s was a period of falling interest rates. It's unlikely that situation will repeat in the 1990s.