Q: We are being offered an FHA Streamline loan. We currently have a 5 percent fixed rate loan. We’re thinking about taking a 3.875 percent 5-year FHA adjustable rate mortgage.
Is this a viable Idea? We are being told that in the worst case scenario, if interest rates were to rise, the rate could only go up 1 percent per year, so it would be 5.875 percent in the 7th year.
Is this truly the worst case scenario?
A: An adjustable rate loan (ARM) generally will have certain yearly caps and will have a lifetime cap. In your case, your FHA loan would become a new loan with a starting interest rate of 3.875 percent. That’s a great rate even by historical standards.
However, the interest rate would only be good for five years. At the end of the 5-year period, the interest rate on that loan would fluctuate depending on where interest rates are in the market.
If interest rates have gone up, the interest rate on your loan will go up. However, the loan may have a maximum increase of one percent per year. So your interest rate for the sixth year might go up to 4.875 percent and the same would be true the following year, with an increase to 5.875 percent.
These loans usually cap the interest rate increase over the lifetime of the loan to five percentage points, so the maximum interest rate for your loan would be 8.875 percent.
If you plan to live in the home only for the next three to five years, this loan might be a good option for you. But keep in mind that you need to make sure that you aren’t paying too much in fees on the loan being offered to you. Even your current 5 percent rate is a pretty good rate.
Interest rates might fall further. This week, the 30-year fixed rate loan reached about 4.25 percent from many lenders (Freddie Mac reported the average 30-year rate as 4.49 percent, a new record low). Interest rates on a 15-year loan were available as low as 3.75 percent.
While all this sounds like nearly-free money, make sure you’re changing your loan terms for the right reasons. If you plan to be in your home for the next 20 years, you might want to consider a longer lock on your interest rate. If you’re having trouble paying your bills, or expect to lose your job or income soon, and have applied for the loan change to reduce your monthly expense, you should also consider cutting other expenses out of your life to give yourself a greater cushion.
While most people usually focus on their loan interest rate, they forget that real estate taxes seem to still be going up along with insurance expenses and other costs. If you are having trouble affording your payments, the new loan might help for a while but you need to make sure you understand and know where you are spending your money to keep your expenses under control.