Should first time buyers use an adjustable rate loan or a hybrid as their very first mortgage? “First timers” when starting out on their home buying journey can be somewhat surprised at all the decisions they must make. The biggest choice is whether or not they want to buy in the first place. Making the jump from being a renter to a homeowner is no small task. Those of us who at one time were first timers know this first hand. Just deciding whether or not to buy also means facing a new round of choices.
Buyers generally start out by speaking with a loan officer who will give them an idea about how much they can qualify for. They ask around and get referrals for a real estate agent who will represent them and help find the right home based on their own criteria. That information of course was obtained by the agent through another series of questions. How many bedrooms? Are good public schools a priority? Commute to work? And those are just for starters. But once these questions are answered and they have their preapproval letter in hand, they must also decide between a fixed rate and an adjustable rate mortgage. Should first timers even consider an adjustable rate mortgage?
Their loan officer will provide the buyers with a menu of loan choices. For a fixed rate loan, the choices range from a loan over 10, 15, 20, 25 and 30 years. Once the proper loan term is selected, they then need to decide which interest rate they should select. Should they pay a discount point to lower their 30-year rate by about 0.25%? Maybe pay no points? Or what about increasing the rate slightly in order to receive a lender credit toward their closing costs?
An adjustable rate mortgage today is primarily in the form of what is known as a hybrid which is in essence and adjustable rate loan (ARM) that is fixed for an initial period of time before adjusting once or twice per year, depending upon what is contained in the note. One of the more common hybrids is what is known as a 5/1 hybrid. The rate is fixed for five years before making the adjustment to an annual or semi-annual ARM.
Which is better for a first-time buyer? That primarily depends on how long the buyers intend to keep the property before they sell and move up to a bigger home. For buyers whose primary concern is being located in a top-notch public school district, they’ll likely be there for a while as they raise their kids and put them through school.
A hybrid ARM will offer a slightly lower rate compared to a fixed rate loan but there is some inherent uncertainty with the ARM once it changes. There really is no way to predict what rates will be in five or seven years. Rates could be much higher wiping out the monthly savings they enjoyed by selecting the ARM over the fixed. The adjustable rate mortgage can certainly be a good plan if they don’t plan on keeping the property for an extended period of time. And that’s the major factor…time.
It’s also important to note that some mortgage programs geared towards first-time buyers, like the USDA loan, only offer a fix rate option. Please contact above to discuss the pro’s and con’s in detail, we’re always happy to help.