Paul Bradbury/Getty Images
- Our family of four is buying a house in Austin, Texas, in 2024.
- Despite enticing alternatives, a fixed-rate mortgage remains the best option for us.
- Alternative mortgages are getting more popular but present too much risk and long-term costs for us.
The current economy has many hopeful homebuyers searching for a way to save on their mortgages.
However, the classic option may still be the best for many of us.
My family of four recently sold our starter home in Austin, Texas, and are now in the market for a new house in a different part of town.
With mortgage interest rates still close to 7%, alternative mortgages like adjustable-rate loans and mortgages with shorter maturities are gaining in popularity. However, after researching and talking to some experts, the pros for those loans don't outweigh the costs, and the classic fixed-rate mortgage is still the best option for us.
The beauty of the fixed-rate mortgage is that it offers certainty in an uncertain world. With a fixed rate, your interest rate won't change, and you will always have the same monthly payment no matter what happens to rates in the future.
Why we are staying away from alternative mortgage types
Some homebuyers want — or need — their monthly mortgage payment to be as low as possible, no matter the long-term costs. However, we are lucky enough to be in a situation that allows us to be picky, and alternative mortgages are just not worth it for us.
The most common of the alternative mortgage types is the adjustable-rate mortgage (ARM), which is especially appealing when interest rates are higher. ARMs still only represent 7% of all mortgages, but that rate has doubled in the last two years as interest rates rose.
With an ARM, you are locked into a lower rate for a set number of years at the start of the loan, and then the interest rate typically adjusts once or twice a year, depending on the rate at the time. The upside is lower payments initially and potentially later on if rates fall, but the downside is a higher monthly payment if rates go up.
An ARM might be a good option if you know you will sell the house before the adjustable rates kick in. That was the recommendation from Sarah Alvarez, vice president of mortgage banking at William Raveis Mortgage, for somebody planning to live in a house for five or six years.
"In this scenario, I would strongly recommend considering a 7-year adjustable product," Alvarez told Business Insider. "You are incentivized with a lower rate and will be paying off the mortgage before the rate leaves its fixed period. In this elevated rate market, it is best to focus on keeping the monthly payments low."
With both of our daughters entering high school in the next two years, there is a good chance we will look to downsize or move in the next seven or eight years, but that is not guaranteed and may depend on what the housing market looks like then.
Brandon Bell/Getty Images
Another problem with the ARM is that mortgage interest rates typically follow the rates for Treasury bonds, with 30-year fixed-rate mortgages following the 10-year Treasury yield and the initial rate on ARMs following the rates of shorter notes like the 1-year Treasury.
Right now, the rates on short-term Treasuries are higher than long-term bonds, a phenomenon known as an inverted yield curve. This means that the introductory interest rate on an ARM based on those short-term Treasury rates might be only slightly better than the more predictable fixed-rate loans that rely on the long-term rates.
And in some cases, the ARM's interest rate can be higher. According to Optimal Blue, a mortgage data company, via The Wall Street Journal, the average initial rate for an ARM in which the first five years are fixed was 7.04% in December. The average rate for a 30-year fixed-rate mortgage that month was 6.86%.
Interest-only mortgages feel too expensive and too risky
Another form of home financing that is gaining in popularity is the interest-only mortgage.
With an interest-only mortgage, the buyer doesn't pay a monthly amount against the loan's principal at the beginning of the loan term but instead pays only the monthly interest.
While the initial monthly payments are much lower, the principal is not being paid down, so the owner is only gaining equity from changes to the value of the initial down payment amount and not from reducing the amount the bank can claim, with a greater risk of losing equity if house values fall.
In addition, the borrower is adding a considerable amount to the total cost of the house in the form of the interest being paid over time.
Buying discount points is popular but may not be worth it
Another common way to lower mortgage payments is with "discount points," in which the buyer pays a lender at closing to lower the interest rate, with one point equal to 1% of the loan amount and each point typically lowering the rate by 0.25%. But it turns out even these are often not worth the cost.
According to Freddie Mac, 59% of borrowers used points to lower their interest rate in 2023, up from 31% in 2021. And yet, according to their research, the average interest rate in 2023 for those who purchased points was 6.61% in 2023, only slightly better than the 6.69% average rate for those who did not buy points.
This shows that the pre-discount rate was higher for people who purchased points and could indicate that lenders view buyers seeking to lower their monthly payments as riskier.
FG Trade/Getty
If you do receive a lower rate by buying points, it may only be beneficial if you plan to stay in the house for a long time, long enough to save more money on interest than the amount spent lowering the rate. However, according to the National Association of Realtors, the typical homeowner only stays in their house for eight years.
We may only own our new house for less than 10 years, so buying discount points could cost us more on our next mortgage.
Sticking with the 30-year fixed-rate after all
While there is no risk of the rate rising, there are ways to lower your monthly mortgage payment with a fixed-rate loan.
In our case, we'll likely be able to put a larger percentage down than when we bought our first house and interest rates were much less of a concern.
We may also choose to go with a 30-year loan at first and then refinance down the road into our preferred 15-year mortgage. This way, we can get a lower monthly payment initially without taking too much of a hit on the interest we would have to pay overall.
The other option for people who want to buy a house is to wait and hope that interest rates fall. However, that is also risky as house prices have remained steady and are even still rising in some places. Any gain somebody might get with a lower interest rate might be offset by paying more for the house.
While there are alternatives available to homebuyers looking to lower their monthly mortgage payments. However, those benefits are often small and end up costing more overall. So, we will be sticking with a fixed-rate mortgage and shopping around for the best rate.
Did you use an alternative mortgage type to buy a home in recent years? Reach out to this reporter at cgaines@businessinsider.com.