How Are The Fixed/Adjustable Rate Loans Designed?

The “Fixed/Adjustable” loans like the 3/1, 5/1, 7/1, and 10/1 have become very popular over the past decade. They will often offer a much lower interest rate during the fixed rate period (the first three, five, seven or ten years) before becoming an adjustable rate mortgage. They still provide that fixed rate for the initial period of time instead of changing to the adjustable feature after six months (typical of your adjustable loans).

These loans are always regarded as “adjustable rate” loans since they become adjustable at some point during their 30 year life. All of these loans are designed for a full 30 years, but they all change from a fixed rate period to an adjustable rate period after the initial three to ten years.

How much are the rates different from the 30 yr. fixed?

Good question. I’m glad you asked. When the fixed interest rates are somewhat high the difference is not too significant. For instance, when the 30 year fixed is at 6.5% the 5/1 will be quoted at about 6.125%. That difference of .375% will be far greater when the fixed interest rates are much lower. Such as, when the fixed rate is 5.5% the 5/1 is often quoted at 4.625%, or .875% lower. In other words, when the rates move up the “spread” between the fixed and the fixed/adjustable rates will become less and less.

Why would I consider a fixed/adjustable ?

There are several reasons that I might consider a mortgage fixed for only the first few years.

• It’s easier to qualify because the payment is less.
• I might not need a longer term loan because of an anticipated move in the next few years.
• I might be planning on remodeling my home and therefore plan to refinance when the job is done.
• Finally, if the rates are high I would expect them to come down in the next few years and then refinance. Why take a higher rate loan if that seems likely.

Your plans and your value system should dictate your decision.

Consider the “sleep factor” when deciding!

I strongly recommend to my clients that they seriously look at what decision will help them sleep best at night. The difference in the payment may not be significant enough if it is going to cause you to worry about the “what if” after the fixed rate period. And I suggest to couples that they let the more conservative person, the one who will worry the most, make the decision. If one of the two partners is kept awake at night, trust me, the other will be more than likely kept awake as well.

I am available to provide what ever consulting you might need as you ponder your options. Have fun!

Peter M. Galde is the founder and principal at Cornerstone Capital Funding, 14500 Mono Way, Suite 110, Sonora Ca. 95370. Peter has 28 years experience in the finance industry. E mail Peter or call him on 209 532 7711 for further information.