Adjustable Rate Mortgage versus Fixed Rate (Finance)?

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Consider the following scenario: John buys a house for $ 150,000 and takes out a five year adjustable rate mortgage with a beginning rate of 6%. He makes annual payments rather than monthly payments.

Unfortunately for John, interest rates go up by 1% for each of the five years of his loan (Year 1 is 6%, Year 2 is 7%, Year 3 is 8%, Year 4 is 9%, Year 5 is 10%).

Calculate the amount of John’s payment over the life of his loan. Compare these findings if he would have taken out a fix rate loan for the same period at 7.5%. Which do you think is the better deal?

2 Comments
  1. Reply
    Positively Pink
    February 15, 2011 at 10:24 am

    You don’t have to calculate any of that to know the fixed rate mortgage is always the better deal. With such a mortgage you know exactly what your mortgage payment will be each month therefore you don’t have the issue of the payment increasing to an amount that the person can’t handle.

    Adjustable rate mortgages are part of what caused the housing market crash. Too many people were given loans they couldn’t afford in the first place and then the payment continued to rise as the rate changed. Before they knew it, their payment was more then they could pay on top of their other bills. In the end, many people lost their home because they only looked at the short term lower interest rate, instead of looking towards the rate they would have later. Sometimes people just don’t look past the end of their own nose.

    To me, this sounds very much like a homework question.

    Brit

  2. Reply
    mpatricia25
    February 15, 2011 at 10:56 am

    Fixed rate is always best, more of your money will go into your principal and faster that an ARM.

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