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Why in Today's Market a 30 Year Loan is King

Apr 14, 2008
In the past I used to tell people to look at different mortgage rates for different loan products and determine what was best for them. If they were planning on moving soon a 5 Year ARM might work. If they planned on staying on the house longer they might consider a 30 Year Loan. I don't say this any longer. Why? Because of recent developments the 30 Year Loan is king. If you can get a 30 Year loan in the current market 95% of the time it's the best choice.

If we look back to the beginning of 2006 both 5 Year ARMS and 1 Year ARMS where significantly lower than the rates on 30 Year Loans.

Begin 2006
30 Year Fixed - 6.22
5 Year ARM - 5.79
1 Year ARM - 5.15

At the time banks saw 5 and 1 Year ARMs as a short time commitment. But now banks are starting to see more foreclosures on ARMs than they are on 30 Year Fixed loans. This has started to make banks more nervous about ARMS. In response banks have raised rates on 5 and 1 Year ARMs even as rates on 30 Year loans have decreased.

If we look at historical mortgage interest rates over the last few years what we will notice is that historically all 3 products moved in concert with each other. But recently that trend has changed. 5 Year ARMs and 1 Year ARMs have gone up while 30 Year Rates have come down. So if we look at the rates today we will find them much closer together than what we saw at the beginning of 2006.

Today
30 Year Fixed - 5.85
5 Year ARM - 5.67
1 Year ARM - 5.24

So how much does this affect your potential mortgage payments? Let's look at the mortgage you would get on a 200k house based on the interest rates.

First let's look at the mortgage payments you would make at the beginning of 2006.

Begin 2006
30 Year Fixed - 1227.53
5 Year ARM - 1172.23
1 Year ARM - 1092.05

So the difference between a 30 Year Fixed loan and a 5 Year ARM was 4.72 percent or $55.30. Now let's look at the mortgage payments one would make based on today's rates for the different loan products.

Today
30 Year Fixed - 1179.88
5 Year ARM - 1157
1 Year ARM - 1103.16

So today the difference between a 30 Year Fixed loan and a 5 Year ARM is only 1.98 percent or $22.88. The difference has decreased by more than half. In addition, if we also consider the fact that mortgage interest rates today are relatively low compared to the last 15 years there is a good chance when ARM's expire interest rates will be higher.

Now if someone is absolutely certain they will sell their house in 5 years it still makes sense to get an ARM. But this is rarely the case. People often move to a city only planning on staying for a few years and then end up staying. Or they end up renting out their house instead of selling. The way life changes it's hard to predict what one will be doing in 1 year much less 5 years. I talked to someone recently that said every time they got a 5 Year ARM on a property they ended up keeping the property for longer than 5 Years and every time they got a 30 year loan they ended up selling in less than 5 years. In summary it's hard to tell what will happen in the future.

In the future the difference in mortgage rates between 30 Year Fixed loans and ARMs might start to make ARMs more attractive. But if you are looking to get a loan in the current market the security of the 30 Year loan outweighs the small savings you would gain from the different ARM products.
About the Author
Ki is a realtor in Austin. He runs a site about Austin real estate that provides users a free search of the Austin MLS along with current information on current mortgage interest rates
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