Buying a Chicago home is full of decisions to make–everything from location to budget to what type of mortgage loan you want. Two types of loans–fixed-rate mortgages and adjustable-rate mortgages–each have their own features and benefits that an individual buyer might want to take advantage of, so how do you decide which is right for you?
The The Wall St. Journal recently reported that 30% to 40% of jumbo loan applications at Bank of America this last July were for adjustable loans. Many buyers are drawn to these types of mortgages because of its low interest rate upfront. For a set time period in the beginning of the loan–three years, five years–adjustable loans offer an interest rate that is lower than what is offered with a fixed-rate loan. After that time period, the mortgage rate will adjust to the current rates, which could be much higher than the low initial rate. Of course, the new rate could also be lower, but given that the current rates are at historical lows, it’s much more likely that the interest rates will go up in the future.
A fixed-rate mortgage is a bit more conservative–these loans typically have a term of 30 years (though could be 15 years as well). Even though you are paying more out-of-pocket money upfront with a higher rate, a fixed-rate mortgage means no surprises down the road. You know exactly what your monthly payment will be for what time period, and that won’t change. Now is an especially lucrative time for Chicago real estate buyers to get a fixed-rate loan because interest rates are historically low, and gives buyers an opportunity to lock that rate in for the next 15 or 30 years.
But while it can be tempting to enter into a loan making the smallest possible payments, my approach is is to be conservative with a fixed-rate loan to avoid the unpredictability that comes with an adjustable rate.
It’s extremely important to discuss the different types of adjustable loans with a mortgage person before getting one, as it’s critical that you as a buyer understand all of the nuances of an adjustable-rate loan or any type of hybrid. A few of the risks for Chicago real estate buyers could include:
-Rate increases: This is the obvious risk, but its effects can be swift. After the fixed-rate period is over, those rates could turn up to five percentage points during the sixth year, and can move by two percentage points each year after that.
-Reduced options: If your ARM switches to an unmanageable rate, it is possible to refinance to a fixed-rate mortgage at that time–but since the ARM increase is based on prevailing interest rates, there’s a good chance that a fixed-rate loan will be just as pricey as an adjustable one.
-Need for equity: If you do decide to refinance out of an ARM, you’d need enough equity in your home to be able to do that. That would require a down payment of at least 30% when you purchase the home. If home values have dropped in the time that you’ve had the ARM, you may have to pay down the loan in order to refinance or stick with the current mortgage.
Many high-end buyers have the cash and assets to support the volatility of an ARM, but in the long run, it is a gamble with your future. Being conservative in financing a luxury Chicago home means making a stable investment that can sustain market changes in the foreseeable future.
To discuss more about financing options for your real estate purchase, contact me at (312) 498-5080 or email me at [email protected]