Mortgages: Interest rates can affect the type of mortgage you choose and dictate when it’s wise to make a change. Here are a few of the factors that can be affected by a swing in interest rates:
Choosing A Mortgage When interest rates are rising, a fixed-rate mortgage is usually a good choice, since it locks in the current rate and protects you from the higher rates to come.
When rates are falling, an adjustable-rate mortgage (ARM) becomes more attractive, as its interest rate changes periodically (usually every one, three, or five years), allowing you to benefit from the new, lower rates. A number of people choose an ARM even when rates are rising. This is because the interest rate on an ARM is substantially lower -- as much as two percentage points lower than that of a 30-year fixed-rate mortgage.
That means you’ll pay less until mortgage rates have increased a full two percentage points. After that, you’ll pay more than a fixed rate. There are also hybrid ARMs, which have a fixed rate for a certain time period -- typically three to 10 years -- and then become adjustable. (A 5/1 ARM, for example, has a fixed rate for five years, after which the interest rate is adjusted annually.)
Hybrid ARMs can be the right choice if rates are likely to rise in the short-term but then flatten or fall. However, these long-term trends can be difficult to predict. When rates are falling, you can save money by moving from a fixed-rate to an adjustable-rate mortgage, so you can benefit from the lower rates.
Refinancing A change in the interest rate trend can make it worthwhile to switch to a different type of mortgage. If interest rates appear set for a sustained rise, switching from an ARM to a fixed-rate mortgage can lock in a lower rate and protect you from higher payments. However, you should make sure that any closing costs does not offset the benefits of refinancing.