First Time Home Buyers: 30-year-fixed vs. 15-year-fixed vs. 5/1 ARM
Finding a loan that works for you is just as important as finding the right home. There are many different types of loans available, each with their own set of benefits and drawbacks, but the most popular loans are 30-year-fixed, 15-year-fixed and the 5/1 ARM. Understanding the differences and aligning the right loan with home ownership goals and plans will ensure you are setting yourself up for the best investment possible.
By far the most popular due to the low monthly payment, 30-year-fixed loans consist of a repayment period of 30 years at a fixed interest rate. In other words, if you receive a loan with an interest rate of 4.12%, the rate will be the same across the life of the loan. On a $300,000 home, your monthly payment would be $1,453 and the total cost of the mortgage would be $523,108. The 30-year-fixed loan has been a popular loan for buyers looking at staying in the home they purchase long-term. As the interest rate fluctuates, and is likely to increase, many buyers have been locking in record low interest rates when buying their homes.
As you might assume, the 15-year-fixed loan consists of a repayment period of 15 years, also at a fixed rate. However, these loans typically have a lower interest rate. Due to the reduction in time and interest rate, you end up paying far less in interest charges. For example, for the exact same $300,000 home, your total mortgage cost would be $379,704 because your mortgage rate drops to 3.26%. However, your monthly mortgage cost increases to $2,109. For those who can afford a larger monthly fee, a 15-year-fixed loan is a great option as it ends up savings thousands over the lifetime of a loan. In this example, you would save $143,404 in interest payments, or nearly half the price of the home!
For many first-time home buyers, your first home may not be your “forever” home and you may be planning on moving after just a few years. In this situation, many will apply for a 5/1 ARM loan. A 5/1 is 30-year adjustable rate mortgage where the first 5 years are at a fixed rate. After the 5 years, the rate will adjust either up or down once a year. The benefit is for those looking to not live in the home longer than 5 years as it saves them on their monthly mortgage due to lower rates than a 30-year-fixed loan. For example, the same $300,000 home with a 5/1 ARM at today’s rates of 3.625% would have a monthly payment of $1,368. Your monthly payment is lower than both 30-year-fixed and 15-year-fixed, however, if you do not sell or refinance your rate could increase dramatically. In the example below, the mortgage period is at 30 years since the length of the loan is 30 years, however, note that this will be your payment for only 5 years, then you will be given a new interest rate each year. Identifying the total cost of the mortgage is impossible with this type of loan as it varies year-to-year.
This type of loan is a bit riskier if you are not careful. For your home purchase to usually make financial sense, you will likely want to live in the house for longer than 5 years. If that is the case, this may not be the loan for you. If you do not sell the home before the interest rate changes, you could be stuck with a much larger monthly payment.
In any of the loan situations, it is important to always make your payments on time and keep your credit in good standing. As the market changes, rates will rise and fall, and you are always able to refinance your mortgage and acquire a lower rate. However, it isn't an easy task to refinance. Putting in the extra leg work to ensure your credit is in good standing to qualify for the lowest rate, and keeping your ear to the interest rate market, can put you at an advantage when you are ready to buy a home. If you are looking to save even more money when buying a home, Faira offers an Offer Assist program where you receive 3% back after closing. For this same $300,000 home in this example, that would be $9,000 in your pocket!