To illustrate the impact ofinterest rates on a residentialmortgage, consider amortgage in the amountof $350,000. Based oncurrent market rates, the interest rateon a 3-year interest-only adjustable ratemortgage would be approximately 5%.
For a 30-year fixed-rate mortgage theinterest rate would be about 5.7%.These rates would be based on the borrowerhaving a good credit history, sothe lower your credit score, the higherthe percentage.
In the case of the 3-year interest-onlyadjustable rate mortgage, themonthly payment would be approximately$1458. This payment wouldbe fixed for a period of 3 years afterwhich time the principal balancewould still be the original amountborrowed since no principal wouldhave been paid, and the interest ratewould then be the prevailing rate ofinterest commanded in the marketplace adjusted annually going forward.If the borrower wishes to avoidannual rate adjustments after the initial3-year period, they have theoption to refinance that existingmortgage executed 3 years earlierand locking in a 30-year fixed-ratemortgage at the going interest rate.
For the 30-year fixed-rate mortgageat an interest rate of 5.7%, themonthly principal and interest paymentwould be approximately $2031a month, or nearly 40% more thanthe interest-only 3-year adjustablerate mortgage. So why would youwant to implement a 30-year fixed-ratemortgage when the interest rateof a 3-year adjustable-rate mortgageis much lower?
Assuming that you employed theinterest-only 3-year adjustable-ratemortgage, at the end of 3 years youstill owe $350,000 on the note.Supposing that interest rates on fixed-ratemortgages have increased by1%, the 30-year fixed-rate mortgageis now 6.7%. Not only will yourmonthly principal and interest paymentnow be nearly $227 more permonth than what it would have been3 years earlier, but you will have themonthly payment of $2258 for 3years more than if you would havetaken out the 30-year fixed-ratemortgage in the first place.
At first glance the temptation maybe to minimize your monthly cost bytaking out an interest-only mortgage.But with interest rates still beingclose to their multiyear lows, itwould be wise to lock yourself into afixed-rate mortgage, especially if youintend to live in your residence for anextended period of time. On theother hand, if you intend to invest inproperties other than your primaryresidence, which you plan to hold fora shorter period of time, then theshort-term interest rate mortgagemay be more appropriate.
Thomas R. Koskyand his partner, Harris L.
Kerker, are principals of the Asset Planning
Group in Miami, Fla, specializing in investment,
retirement, and estate planning. Mr.
Kosky teaches corporate finance in the
Saturday Executive and Health Care Executive MBA Programs
at the University of Miami. He welcomes questions or comments
at 800-953-5508, or visit www.assetplanning.net.