Mortgage rates may have gone up slightly, but that doesn’t mean you can’t save money over the life of your mortgage. It may seem counterintuitive, but there are ways to pay less interest over the term of your mortgage even in a rising-rate environment.
The remainder of this post will discuss your two best options to do this, but first we’ll go over one feature of this interest rate landscape that may actually be beneficial to you.
When interest rates rise, the bank has to pay more money to other banks in order to borrow funds from them to make loans. One of the side effects of this is that it makes the money the bank currently has (the money in your checking and savings accounts, for example) worth that much more.
As interest rates rise, a competitive bank will increase your deposit interest rate in order to encourage you to keep your money with them so they can continue to lend it out to others.
In a similar effect, rates for things like bonds and certificates of deposit (CDs) should go up as well to attract investors. You may have to pay a little more for your mortgage, but at least some of it should be offset by the fact that you should have more savings at your disposal.
Go Adjustable and Save
Whether you’re looking to buy or refinance, an adjustable rate mortgage (ARM) could be a great option to look at, particularly in an environment where interest rates are on the rise.
There are a lot of misconceptions on ARMs, so let’s start by explaining how they work.
The beginning of any ARM includes a period of time when the interest rate is fixed. Commonly, this lasts for a period of five, seven or 10 years. You get a lower beginning interest rate on an ARM than you would on a comparable fixed-rate mortgage.
According to the National Association of REALTORS®, the average person will stay in their home for a period of 10 years. This means if you went ahead with a 10-year ARM, you could very well be poised to move into your next home before your monthly payment ever changes.
One factor to be aware of when going with an adjustable rate is that if you’re getting a conventional loan, you’ll end up paying a higher down payment – or needing more equity to refinance – than you would on a fixed-rate loan. This is part of your assurance for mortgage investors that you have the financial resources to handle it if the payment goes up.
If you end up staying in your house past the expiration of the fixed period, you have a couple of options: you can refinance into a fixed rate or let it adjust.
After the fixed period is over, your ARM adjusts on a yearly basis. If your mortgage is a conventional loan backed by Fannie Mae or Freddie Mac, your loan adjusts based on the movements of the one-year London Interbank Offered Rate (LIBOR). If your arm is through the FHA or VA, your rate adjusts based on the one-year constant maturity treasury (CMT).
Regardless of which index’s number is used, it’s then added to a margin to determine your mortgage rate for the coming year. The exact number used to determine the margin depends on the type of loan you have.
Despite being somewhat at the mercy of the financial markets, your ARM can’t go up indefinitely. There are caps on how much your rate can adjust over the course of the year as well as throughout the term of the loan. The exact figures used for the caps vary depending on your loan type.
Shorten Your Term
The other way to save on interest is to shorten your term. Mortgage investors are willing to take a smaller return if they can be guaranteed a quicker payoff.
Going with a shorter term doesn’t mean having to always put your entire paycheck toward your monthly mortgage payment. On our conventional products, we offer something called the YOURgage. This is a fixed-rate loan where you can pick any term between eight and 30 years. You may find that you’re able to shave a few years off without breaking the bank.
This also brings up some neat scenarios. Let’s say your child was just born. You could choose to take a mortgage term of 18 years in order to have the mortgage paid off by the time they’re ready for college, so you can put that money toward tuition and other expenses. This is also useful if you have an idea of when you want to retire.
In both of the above scenarios, you get the dual benefit of being able to ditch your monthly mortgage payment sooner and paying less interest over the life of the loan.
If you have an interest in saving on interest, go ahead and get started online or feel free to contact one of our Home Loan Experts at (888) 728-4702. If you still have questions, feel free to leave them in the comments below.
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