A Quick Look At Mortgage Rates

(Amended after additional support from my good friend and quant geek Morgan Snyder)

It's interesting to look at mortgage rate options for home-buyers today. Even with a relatively flat yield curve, a 5 or 7 year arm might be worth looking at versus a 30 year fixed rate.

Please note: picking the best mortgage for you is a personal decision based on considerations as to how long you intend to keep the home, how long you may keep the mortgage before refinancing, how your payment could change at the end of the initial fixed ARM term, cash flow needs, as well as other considerations. Discuss all of these with your financial adviser as well as your mortgage lender before making a decision.

There are many sources to look at rates, but for this purpose I consulted the Freddie Mac weekly rate survey. Here is what I found and, again, all rates are from the Freddie Mac survey and will vary from lender to lender as these are their averages. There are also other surveys and individual lender rate quotes widely available online.

The average Freddie Mac conforming (non jumbo) 30 year fixed rate is 4.52% and the average 5 year arm is 3.87%. So, what does this mean?

I used a $400,000 loan. You can adjust higher or lower and the payment difference would be relative to loan size. In this case, here are the results. The 30 Yr Fixed Rate Payment is $2,031.50 while the 5 Yr ARM Payment $1879.81. The difference in payment is $151.69 and the five year savings is $9,101.40

$9k is not a small number, but there are additional benefits here. The lower rate ARM pays down your loan balance faster so that the principal balance after 5 years for the two Arm is $361,025 versus the fixed rate at $364,742. That’s $3717. That’s increases your savings by an additional 40%.

The combined savings of approximately $12,700 after five years could help in many ways. It could help offset expenses such as utilities or other expenses to support the home. The cash flow could be deposited monthly into savings or a 401k if desired to help build up a reserve in case of emergency. The better equity buildup means more long term value when you sell. But the real question, given the obvious benefits of the savings is, what happens after year 5?

After year five the loan will adjust or the borrower will refinance, or maybe the owner is already planning to sell. In this example, the remaining balance on the $400,000 loan is $361,025. The question then is, how long will you stay in the home after 5 years? If this was a first time home-buyer the data will show that you may be nearing the time when you will consider selling. Suppose for a moment that you will sell in three years. Under that scenario the simple math would say that your payment after the five years would have to rise by $252.81 per month ($9101.40 divided by 36) to use up the cash flow savings you earned over the lower rate for the previous five years. If you include the additional equity of the lower balance then it's really $356 per month that it would have to rise.

These are complicated decisions with many moving parts that depend on your long term view of the home you are buying, your desire for short term savings and your ability to manage a potentially higher payment in the future, or when you may sell or refinance, and more. But the borrower of today should at least ask about terms on a 5 or 7 year arm to compare against a 30 year fixed rate and look for themselves. As rates rise, this difference could be even more meaningful when home shopping.

Just a thought - worth the look. Happy home shopping!