A better mortgage fit: fixed or adjustable?

Integrated calculators help you decide

By Inman News Feed
Add Comment Add Comment | Comments: 0 | Posted Jan. 2, 2012

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Integrated calculators help you decide

Jack Guttentag
Inman News®

Editor's note: This is the first of a two-part series.

In many, if not most, countries, borrowers are offered one type of mortgage: Take it or leave it. Borrowers in the U.S., however, can choose from a large menu of mortgage types designed to meet different borrower and lender needs.

These include fixed-rate mortgages (FRMs) with terms ranging from 10 to 40 years, and adjustable-rate mortgages (ARMs) with 30-year terms but initial rate periods ranging from one to 10 years. Many of these mortgages have an interest-only payment option for the first five or 10 years. And all are offered with multiple combinations of interest rate and lender fees.

Difficulties in making decisions

But having options is as much a curse as a blessing to borrowers who have no idea of how to make a selection. Most focus on the immediate financial burdens imposed by the mortgage, and give little thought to the future.

The loan originators (LOs) who borrowers encounter in the process are seldom helpful because their time horizon is even shorter than the borrower's.

They want the loan to close so that they will get paid, and they fear that extended discussions of different loan types and options will slow down the process, and perhaps derail it altogether.

Their impulse is to suggest the loan type that the borrower might find acceptable, which may or may not be the best. Many LOs are not qualified to counsel borrowers effectively, even if they wanted to do so.

Using calculators to maximize future wealth

Borrowers should aim to be as wealthy as possible when their mortgage is paid off. To meet that objective, and subject to the constraints discussed below, a borrower should select the mortgage that has the lowest net cost over the period he or she expects to have the mortgage.

This approach is used in two new integrated calculators on my website. One enables the user to find the lowest-cost type of mortgage, while the second finds the lowest-cost combination of interest rate and lender fees on the selected type of mortgage.

These calculators are integrated in the sense that they use live market-price data provided by participating lenders, and the prices have been personalized to the characteristics of the user.

Selecting the best type of mortgage

The selection process is illustrated by the table below, which compares the total net cost of an FRM and an ARM. The comparison is made over five years using a tax rate of 25 percent and an investment rate of 2 percent. These assumptions are all specified by the borrower.

Total Net Cost: Two $270,000 Loans on Dec. 8, 2011

 

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