INFOGRAPHIC: California Sales Report For February 2018

8 Tips to Maximize Your Chances of Profiting When Selling

Every home seller wants to get as much money as they can from their sale. If you’ve owned your home for a while and the real estate market in your area is healthy, odds are your home is worth a lot more than what you paid for it. But there are other ways for you to increase your profits even more.

Here are some ways to boost your profit margin when you sell your home.

1. Don’t Advertise Your Motivations

You could be in a position to want to sell quickly and unload your property for whatever reason, but don’t let buyers know that. Any indication that you’re in a bit of a rush to sell will do little for your pocketbook. Buyers are always sniffing out deals, and they may lowball you if they think you’re in a position to sell fast.

Revealing your motivation to sell could compromise your negotiating power with buyers. Instead, keeping your motivations to yourself and your agent will help you increase the odds of selling for a higher price.

2. Price it Right

One of the best determining factors to selling for a profit is the price point that you list at. It’s absolutely critical to list at an appropriate price that’s in line with the current market, regardless of where you stand as a seller.

This is one of the many times that having a real estate agent in your corner is extremely handy. Your agent will pull a report listing comparable homes in the area that recently sold so that you can get a better idea of how much you can realistically list at.

You might be tempted to list very high in an effort to sell high, but that tactic typically backfires. Prospective buyers will simply overlook your listing if you’ve priced well above what the current market dictates. You’ll wind up with a stale listing that will sit on the market longer than it needs to.

At this point, your listing will become vulnerable to lowball offers as buyers may assume you’re more desperate to sell. That’s the last thing you want to do as a seller looking to make a profit. If your home is priced too low, you might get a quick offer, but you could lose money because the offer is below what it should be.

In either scenario, you risk losing money. Make sure that your property is priced appropriately for the current market in order to get the best price.

3. Invest in Professional Home Staging

Buyers are drawn to homes that they are attracted to and are able to easily and quickly develop an emotional attachment to. The best way to make sure your home is aesthetically appealing to the buyers looking in your area is to stage it appropriately. That means giving it a thorough cleaning job, neutralizing the decor, depersonalizing, and furnishing according to what your target buyer is looking for in a home.

While you may be able to tackle this job on your own, you stand a much better chance of attracting buyers with the help of a professional home stager. These experts are skilled at identifying the type of buyers searching in a particular neighborhood and understanding exactly what they’re looking for in a new home.

By determining what these people want, stagers are able to decorate and furnish a home appropriately to attract as many buyers as possible. By doing so, the odds of selling faster and for more money are a lot higher.

While it’s true that you would have to pay a home stager up front for their services, it shouldn’t be looked at as another expense. Instead, home staging should be viewed as an investment. You can recoup all the money you spend on paying a home stager while still getting even more money back when you sell. If using these services helps your home sell for just 1% more, they’ll more than pay for themselves.

4. Take Beautiful Real Estate Photos

In addition to the right listing price, one of the most important factors when selling a home is the quality of the photos used for marketing. High-quality photos are absolutely crucial for presenting your home in the best light possible. Considering the fact that most buyers start their search for a home online, you’ve got to make sure the images you have posted are as good as they can possibly be.

Many buyers end up choosing homes based on how well they’re presented in photos. You’ve only got one chance to make a first impression, and good-quality photos are the way to capitalize on that.

5. Make the Right Improvements

If your home could stand a little bit of improvement, making the necessary upgrades can help add more value to it come sale time. Of course, this work will cost you some money, but if you focus on the right types of improvements, you can realize a better ROI.

Upgrading your home can eat into your profits, but certain jobs can actually help you to sell your house for more money. For instance, painting has been shown to be one of the best improvements to make to a home when it comes to the cost versus the perceived increase in value. For just a couple of hundred dollars and a weekend worth of work, you can make your home appear much more attractive to buyers and even command more money at the negotiating table.

Other smart improvements that bring in a healthy ROI include refacing kitchen and bathroom cabinets, painting the front door, and boosting curb appeal. Just make sure to choose your upgrades wisely in order to recoup as much money as possible at the negotiating table.

6. Know Your Buyer

It’s helpful to understand your buyer’s motivations when you’re at the negotiating table. You want to be in the driver’s seat when wheeling and dealing in order to get the price up as much as possible.

Does the buyer have to buy quickly because they’ve already closed on their current home? Are they financially capable of paying what you’re asking? Knowing the answers to questions like these can help you control the negotiating process and sell for top dollar.

7. Maximize Your Tax Benefits

While selling your home for a high price is your main objective, you can keep more money in your pockets when it comes time to pay taxes. Any profit you make on the sale of your home could be slashed because of the big tax cut you’ll have to make if you simply take those proceeds and put them in the bank.

The good news is that there are some ways to minimize your tax payments. You can deduct some of your taxes on things such as your closing costs, marketing costs, and realtor commissions. Make sure you get a tax professional on board to help you take advantage of all the tax breaks possible.

8. Work With an Experienced Real Estate Agent

While real estate agents are paid by commission, their fee is well worth it. Not only can these professionals help you make the most money on the sale of your home, they can also help you save as much money as you can in several other areas of the sale process.

The Bottom Line

Selling for top dollar is obviously one of your top priorities. By implementing any one – or all – of the above tips, you can realistically increase your profits when you finally close on a real estate deal.

6 Reasons to Reduce the Price of Your Home

No seller ever wants to have to reduce the price of their home,  but sometimes it might be a necessary step to sell in a reasonable amount of time. Of course, all sellers want to make the most money on the sale of their property, but they can only realistically demand an amount that’s in line with the current market.

If your home hasn’t sold yet, there may be a number of reasons why. In many cases, a price reduction might need to be considered.

Here are a few reasons why you may want to think about lowering the price of your home.

1. Showings Are Scarce

If your home isn’t attracting much attention and isn’t getting many showings booked, there may be something wrong. While it could be any number of things, one of them could be the price. If hardly anybody is visiting your home, the odds of selling are pretty slim.

The first week is when activity should be at its highest. That’s because buyers want to be able to snag a potential property before anyone else does. If your listing isn’t getting much action even during this busy time, there’s a problem. At this point, you may want to revisit your listing price to see if it’s still in line with the current market.

2. There Have Been Lots of Showings, But No Offers

You want to have an attractive listing that will draw in as many potential buyers as possible. But even if your home has had several showings booked, that doesn’t always mean that the offers will quickly follow. If you’ve had a number of showings on your home with no offer, there’s an issue.

Sure, it could be that buyers have discovered something wrong with the home or were not keen on the layout or decor. But it could also be the price that has them turned off. While your home may have been attractive enough to view it in person, the price may be a hurdle that buyers may not be willing to climb over if it’s too high. Listing agents will typically speak with buyer agents to find out what turned buyers off, and quite often it’s the price.

The last thing you want is to allow your listing to become stale. If your home has been viewed by many buyers but you haven’t gotten an offer yet, you may want to think about lowering the listing price if appropriate. 

3. You Need to Sell By a Certain Date

If you’re highly motivated to sell but aren’t getting any offers as soon as you expected, reducing the price might be an option. There may be several different reasons why you have to sell quickly. Maybe you’ve had a job offer that’s relocating you to another city and you need to move right away. Or perhaps you’ve already bought another home and it closes soon. Whatever your motivation, selling your present home in a short time period may be difficult at your current listing price.

Speak with your real estate agent about the possibility of lowering the price in order to garner more attention and sell sooner rather than later. It may be worth it to reduce the price in order to keep things more streamlined and stress-free, especially if you’re on a deadline to sell.

4. Other Similar Homes Are Selling a Lot Faster

If you notice that your home has been sitting on the market for a lot longer than other similar homes in the neighborhood before selling, it could be your price that’s stalling the process. You should find out the average number of days on the market (DOM) for homes like yours in your area.

If, for instance, that number is 20 and your DOM has already hit 40, it may very well be the price that’s preventing you from selling within a shorter time frame.

5. Your Home Needs Updating and Repairs

If your home is in need of a little TLC and your price doesn’t really take into account the money needed to bring it up to par, a price reduction may be warranted. Buyers are going to account for any expenditures needed to make repairs or updates to your home and will likely factor that into their offer price. Any issues with your home will be noticed by buyers and will influence what they believe your home is actually worth.

If you’re not able to make these updates yourself, your price should be set accordingly to make up for what buyers would have to spend themselves. Maybe you initially thought that your price reflected the required updates, by perhaps not accurately enough. Don’t forget that many buyers are looking for move-in ready homes and will likely reduce their offer prices when looking at properties that require some improvements.

6. The Market Has Changed

The real estate market is always changing, and some markets move faster than others. Perhaps the price you initially listed at accurately reflected the market at that time, but maybe things have changed since then. It might be worth it to take another look at the current market and see how your home’s value has potentially changed.

If there’s been a slight decline in real estate in your area, you made need to tweak your listing price to reflect that.

The Bottom Line

The listing price is one of the most important factors in selling a home. An accurate price will help bring the most attention to a property and generate interest in it. That being said, there may be times when a change in listing price is necessary, especially if a home is not selling in a reasonable amount of time.

Consult with your real estate agent about the possibility of lowering your price. Your agent will help you decide whether or not to reduce it, and by how much in order to realize a successful real estate transaction.

8 Renting Myths, Debunked

Whether you’re currently on the prowl for a rental unit or are just casually considering renting, there’s a lot to think about. The thing is, there’s a lot of information about renting floating around out there, much of which is true, and a lot that isn’t.

Here are a few myths about renting that should be quashed.

1. Rent prices can’t be negotiated.

Not only is the location of a rental a predominant factor in your search for your next home, so is the rental price. You likely will only look at listings that fall within a certain price range. But the posted rental price isn’t written in stone. Many landlords are open to negotiating on the price.

There’s no reason why you shouldn’t try to wheel and deal with a landlord to see if the price can be lowered. Even if there’s no wiggle room with the price, you may be able to get the landlord to throw in other incentives, such as waiving the security deposit or offering an additional parking spot. 

2. Your rental application won’t be approved with a poor credit score.

Yes, your credit score weighs heavily on your landlord’s decision to approve your rental application. In fact, your credit score plays a key role in many of life’s financial situations, which is why it’s always advised to take measures to ensure it stays healthy.

That being said, a sub-par credit score doesn’t always automatically mean a rental rejection. Sure, it will make it a lot tougher to snag a rental unit, but you won’t be immediately disqualified as a result in all case. Other positive factors may help your position, such as raving reviews from previous landlords or paystubs showing a substantial income.

3. You’re stuck with the lease until it expires.

Generally speaking, you’re tied to your lease when you sign it. This binds you to all the terms of the lease, including the expiry date (assuming all terms are legal). But that doesn’t mean there is no way for you to get out of your lease legally. If there is a lease break contingency somewhere in the lease, you might be able to use that as a way out.

For instance, some lease termination policies might require a penalty fee to be paid if you break the lease before the expiry date. Or, the policy could require you to surrender the security deposit.

In addition, there may be certain circumstances whereby you may be legally allowed to break your lease:

  • You’re starting a tour with the military;
  • Your landlord or neighbors are harassing you;
  • The unit is deemed unsafe or uninhabitable;
  • You suffer a significant medical situation.

Speak with a real estate agent to find out all of your rights as a tenant to break your lease.

4. Your landlord can enter your property anytime.

As a tenant, you have the right to quiet enjoyment of your rental. Your landlord needs to respect your privacy while you’re living there, which means they typically have to provide you with notice before they enter your unit and have good reason to. Typical reasons for landlords to want to enter a rental property include making repairs and showing the unit to a prospective buyer.

However, there may be times when a landlord can enter a tenant’s property with no notice or warning, but only during times of emergency.

5. Your landlord can end your lease at any time.

Your landlord needs to abide by the terms of the lease, and that includes adhering to the lease end date. Under normal circumstances, a landlord cannot evict you for no valid reason. There must be adequate proof that you’ve violated your lease terms and evidence that an eviction is justified.

Your landlord can’t just kick you out on a whim, especially if you’ve been following the terms of your lease. If your landlord wants you out, the situation will likely have to go through the courts.

Having said that, a month-to-month lease makes it easier for landlords to evict their tenants. In this case, you will need to be provided with between 30 to 60 days’ written notice from your landlord informing you that you are required to move out, and your landlord doesn’t really need to offer a reason for ending the lease.

6. Your landlord is responsible for all maintenance and repairs.

Landlords are definitely obligated to perform certain repairs and maintenance duties, but tenants shouldn’t assume that they’ll take care of everything. According to California law, landlords are responsible for repairing significant issues in order to adhere to local and state laws regarding suitable habitation. However, landlords do not have to make any repairs for damages that the tenant is responsible for.

As far as minor repairs are concerned, these stipulations should be detailed in the lease agreement.

7. Anything the landlord includes in the lease is enforceable.

Usually, anything that has been detailed in a lease agreement is considered legally binding. That is, however, unless the items are considered unlawful according to local, state, and federal law. Anything that is not legal under the law is not enforceable.

8. Renting is only for those who can’t afford to buy a home.

While there are certainly a large proportion of renters who continue to rent because they are unable to afford a home purchase, there are others who do it as a lifestyle choice.

Some may enjoy the flexibility that comes with renting and the ability to move without having to sell first. Others prefer to gauge what it would be like to plant roots in a specific area and choose to rent for a while first before buying.

Not all renters are those who can’t afford to buy; instead, it’s a choice for many.

The Bottom Line

Not everything you hear about renting is necessarily true. Whether you’re just contemplating renting or are already actively looking for a place, be sure to sort out truth from fiction, and the best way to do that is to team up with an experienced real estate agent.

INFOGRAPHIC: California Sales Report For January 2018

7 Things Mortgage Brokers Want Borrowers to Know

Just the thought of having to go through the mortgage process after deciding to buy a home can seem daunting for the average buyer. It can seem like a complicated process with all of the numbers and calculations involved.

However, with a seasoned mortgage broker in your corner, the process doesn’t have to be overwhelming or even confusing, These professionals will guide you every step of the way to make sure you take the right steps and find the best mortgage suitable for your financial position.

But there are things borrowers can do that will not only make the job of a broker easier, but will help ensure the process benefits buyers in the end. Here are some things that mortgage brokers wish all borrowers knew.

1. Borrowers Should Call Brokers Before They Start Their Home Search

Of course, you should have a real estate agent by your side before you ever start pounding the pavement in search of your new home. But your agent shouldn’t be the only member to add to your team right off the bat: your mortgage broker should also be one of the first people you call.

Your mortgage broker will be able to work with you to find out all the ins and outs of your financial situation so that you can better focus on the properties that fit within your budget. They will also be able to get the ball rolling to get you closer to final mortgage approval so that there’s no unnecessary delay once you finally find a home you love and submit an offer on.

Buying a home is a big deal, and your mortgage broker will be able to help you through the process by offering you personalized advice based on your particular situation. You want to make sure your hard-earned money is being spent wisely, and your broker can help you do just that.

2. Pre-Approval Isn’t the Same as Final Mortgage Approval

Getting pre-approved for a mortgage is a logical first step in the home buying process. While not mandatory, a pre-approval gives the lender the chance to check your credit and assess your finances. Once this is done, the lender will tell you how much you would be able to borrow.

A pre-approval is very helpful when you are searching for a home. Not only will it help you stay focused on a specific price range, it will help sellers look more favorably on you. After all, sellers tend to want to work exclusively with buyers who are serious about buying and are financially capable of affording the purchase.

But as helpful as a mortgage pre-approval is, it’s not the same as a mortgage approval. The actual mortgage approval process begins after your offer on a home has been accepted by the seller and is submitted to the lender. Borrowers should know that not only does their financial situation impact final approval, so does the home itself.

Lenders will send out an appointed appraiser to appraise the value of the home you agreed to purchase. They will want to know if the accepted offer price closely matches the actual current market value of the home.

Only after the lender is satisfied with all factors involved will a final mortgage approval be granted. It’s possible to be denied a mortgage even after you’ve been pre-approved if the appraisal comes in too low or if there’s been a significant change in your finances.

3. A Broker Isn’t a Lender

A lender is the actual entity or institution that loans out the funds approved for. On the other hand, a mortgage broker is a professional who acts as a middleman between borrowers and lenders. Brokers shop around with various lenders to find the best rates and terms for their borrower clients that they work with, and should not be confused with the people who actually loan out the money.

Mortgage lenders are direct lenders who are able to loan money, while a mortgage broker obtains several quotes from different lenders for comparison purposes. At the end of the day, it’s the lender who has the power to approve or reject mortgage applications.

4. You Need Money For More Than Just Your Down Payment

If you’re applying for a mortgage, you’ll need to come up with a certain amount of money for a down payment. Different mortgage types come with their own down payment requirements, but you can generally expect to require at least 5% for a conventional mortgage or 3.5% for an FHA-backed mortgage.

That said, a down payment isn’t the only upfront cost you’ll need to consider. As much as a down payment will be, the closing costs associated with buying a home and obtaining a mortgage can be pretty significant as well. It’s important that you understand what these closing costs are and budget accordingly before agreeing to make a home purchase.

Generally speaking, buyers pay anywhere between 2% to 5% of the purchase price the home in closing fees. That means you’d be paying between $10,000 to $25,000 in closing costs on a $500,000 home purchase, which can include anything from appraisal fees, to home inspections, to private mortgage insurance. Your Closing Disclosure will detail all of the closing costs you’re responsible for before you sign on the dotted line.

5. Borrowers Should Never Make Any Major Financial Changes During the Mortgage Process

Your lender is making a decision about whether or not to approve your home loan application based on the financial information given at that time. If you make any changes to your financial situation, that could throw a wrench in the process and potentially even sabotage your mortgage approval, or delay it at the very least.

Mortgage brokers work hard at collecting all the necessary financial information from you and communicating it to the lenders they work with. They’ll usually tell their clients not to make any major financial decisions until after final mortgage approval.

Generally speaking, brokers advise against borrowers making any large purchases on credit, such as taking out a loan to buy furniture, applying for an auto loan, or taking out a new credit card. These can all alter your debt-to-income ratio which is a critical factor used when assessing your ability to get approved for a mortgage. In addition, you shouldn’t change jobs during the mortgage approval process either, as this can also delay closing.

6. Borrowers Usually Don’t Get a Bill From Their Brokers

Borrowers often wonder how much a mortgage broker will charge for their services, which is a valid inquiry. While buyers may sometimes pay their mortgage broker’s bill in the form of a percentage of the loan amount, brokers typically get paid a commission from the lender who ultimately provides the mortgage.

Depending on the type of home loan provided and what the lender offers, this amount can range anywhere from 0.50% to 1.50%. Based on a mortgage amount of $400,000 and a commission of 1.0%, for instance, the broker would be paid a one-time commission of $4,000 from the lender. Since this comes directly from the lender, borrowers never actually get a bill.

7. The More Documentation, the Better

Brokers require very detailed information about your finances before they’re able to get an accurate quote from the lenders they deal with. Any missing information or documentation will just make the broker’s job more difficult and will take longer to get any answers from lenders.

The more documentation you can provide your broker, the higher the odds that the process can move along quicker. Ideally, all of the required documents should be provided upfront all at once rather than sporadically submitted. Your broker will give you a checklist of documents you’ll need to provide so there’s no guesswork involved.

The Bottom Line

Everyone involved in the home buying and mortgage process should have a full understanding of what their duties are to ensure a smooth process, including borrowers. As a buyer and a borrower, knowing what you’re responsibilities are will not only help your mortgage broker get you the best home loan product for you, it will also help you be more informed from start to finish. Make sure to get up to speed on what you can do to help your mortgage broker help you with your home loan approval process.

What is a Kick-Out Clause in a Real Estate Contract?

Many buyers are not able to afford the purchase of a new house until their current home sells first. Once their home sells, they can use the proceeds of their sale to be put towards to the purchase price of a new home. Even those who may be able to afford a new home without first selling their current property might not necessarily want to carry two mortgages until their current home finds a buyer.

In order to solve this issue, many buyers choose to make their offers contingent on the sale of their home. If their current property does not sell within a certain time period, they would then be free to walk away from the deal and not have to commit to buying a new home.

While this might sound ideal to buyers, it’s not exactly an attractive proposition for sellers. After all, sellers could wind up waiting for weeks until the buyer sells their home until closing. If the buyers are not able to sell their house during the specified time period, then the purchase agreement will become null and void and the buyers can walk away from the deal.

During this contingency period, the sellers would have lost out on other potential offers. That’s why many sellers tend to look unfavorably on real estate contracts that are contingent on the buyer’s ability to sell their current home.

However, sellers might have some recourse if they agree to entertain this type of contingent offer: with the inclusion of a “kick-out clause.”

What exactly is a kick-out clause, and how can it benefit sellers?

Kick-Out Clause: Defined

A kick-out clause is included in a real estate contract to allow sellers to nullify their agreement if they receive another offer from another buyer prior to closing. This clause allows sellers to continue to market their homes for sale in case another prospective buyer expresses interest in purchasing the home and submits a more attractive offer.

Basically, the seller is allowed to “kick out” the original buyer if another offer comes in. With such a clause in place, the seller can then cancel the contract and enter another one with a different buyer.

Sellers should include a time frame within which they are obligated to inform the original buyer, who will then have the opportunity to waive the contingency to sell their home and agree to purchase the new home. Otherwise, they can back out of the deal and allow the seller to continue entertaining another offer. While this time period can vary, 72 hours is typical for this type of contingency.

Can the Buyers Afford Your Home Without Selling Theirs First?

A kick-out clause is great for sellers in that it allows them to avoid wasting any time that could have been spent marketing to others and finding a better offer. Under this agreement, the potential buyer can have the contingency removed and carry on with the deal if the seller finds someone else who is interested in the property.

But sellers need to be satisfied with any evidence that the buyers have shown regarding their ability to afford a home purchase without having sold their present property. Buyers will need to show sellers that they are still capable of securing a mortgage for a new home purchase, regardless of whether or not they’ve been able to successfully sell their home.

Many times buyers won’t be able to get approved for a mortgage because they don’t have the financial means of carrying two mortgages at the same time. Sellers need to be aware that if they choose to work with the original buyers after waiving their contingency to sell their home, the buyers must strong proof that a mortgage approval is imminent.

Kick-Out Clauses Offer a Meeting Ground Between Buyers and Sellers

A kick-out clause allows buyers and sellers to compromise with each other if there is another property in the picture that must be sold. That being said, sellers should require that buyers start marketing their home right away. The sooner the home is listed and marketed, the sooner it will be able to find its own buyer and sell in time to put the proceeds of the sale towards the new purchase.

It’s recommended that sellers carefully word their kick-out clause to ensure it clearly stipulates that if the buyer fails to list and start marketing their home within a specified time frame, the seller can then exercise the right to nullify the purchase agreement and look for a different buyer.

The Bottom Line

It’s not uncommon for some buyers to want to ensure their current home is sold before they agree to buy another house. Nobody wants to have a mortgage on two different properties if it can be avoided. That’s why some buyers choose to insert a clause in their real estate contracts that give them the chance to sell first before buying another home.

But from a seller’s point of view, that’s a gamble. They could very well be sitting around waiting for the buyer to sell their own home, when this may never happen. In the meantime, they could have lost out on countless other potential offers, which may have been even better than the one they’re currently entertaining.

That’s why kick-out clauses exist. they offer a compromise for both parties to help ensure a deal is successfully completed. But sellers need to make sure that their kick-out clause is carefully written and detailed with the help of a seasoned real estate professional in order to avoid any loopholes.

Questions to Ask Before Choosing Between an Adjustable-Rate or Fixed-Rate Mortgage

It’s the age-old question when it comes to taking out a home loan: should you go for an adjustable-rate or fixed rate mortgage?

The answer to that question depends on a number of factors, including your specific financial situation and the temperature of the current market.

Fixed-rate mortgages lock you into a specific interest rate for the entire loan term. Many borrowers like the idea of having a rate that never changes so that they can budget more easily and not have to deal with fluctuating monthly payments.

Adjustable-rate mortgages (ARM), on the other hand, mean that the rate – and therefore the monthly payments – can change throughout the loan term. Many borrowers choose to risk the potential change in rate and payments in order to take advantage of the more attractive interest rates, as initial ARM rates tend to be lower than those of fixed-rate mortgages. 

But the decision to choose one type of mortgage over the other is not so cut and dry. There are important factors to consider before making your decision, as one can end up being a lot more expensive than the other.

Here are some questions to ask when considering adjustable-rate mortgages versus fixed-rate mortgages.

How Long Do You Plan To Live in Your Current Home?

If you’re planning to stay put in your home for many years, a fixed-rate mortgage is typically recommended, especially if you can lock in at a relatively low rate. On the other hand, if you have plans to make a move some time over the short-term, an adjustable-rate mortgage might make more sense.

Your monthly loan payments will be lower, allowing you to save a little more each billing cycle. If you’re moving before the adjustable rate period starts, you shouldn’t be vulnerable to any significant interest rate adjustments.

What Are Interest Rates Like Right Now?

The temperature of the interest rate environment is a crucial factor to consider before deciding between an adjustable-rate versus fixed-rate mortgage. When rates are high, fixed-rate mortgages are more expensive. You’d be locking in at a high rate for a few years, making your mortgage more expensive and leaving you stuck with a high rate that could go down at some point in the near future.

In this case, you could be missing out on significant savings. When rates are high, an ARM might make more sense because their initial rates are lower than fixed-rate mortgages. If rates dip shortly afterward, you’ll have the benefit of having lower payments.

However, if rates are particularly low, locking in with a fixed-rate mortgage might make more financial sense, especially if rates are expected to rise in the near future. By locking in at a low rate, you won’t have to worry about it rising for the next few years until your term is up and your mortgage is due for renewal.

Would You Be Able to Comfortably Make Mortgage Payments if Rates Increase?

An important factor to think about when considering an adjustable-rate mortgage is what your tolerance for risk is. Will your current or future income be able to comfortably support a more expensive mortgage if the interest rate rises on your ARM? Even the slightest increase in rates can make a big difference on your mortgage payments.

While the initial monthly payments on an adjustable-rate mortgage might be affordable for you today, what will they be like if rates rise in the near future? If the initial mortgage payment amount is already at the limit of what you can afford, an adjustable-rate mortgage might be too much of a financial risk for you. Instead, a fixed-rate mortgage will afford you with more predictable payments to fit within your budget.

What About “Caps”?

Adjustable-rate mortgages involve rates that fluctuate on a regular basis, but in order to make sure they don’t swing too wildly, they come with “caps.” These caps ensure that there are limits set on how far interest rates can go when the loans are adjusted. They can also limit how much monthly payments can increase.

If you’re leaning towards an ARM, be sure to identify exactly what the caps are first.

Caps are expressed as a ratio of three numbers:

Initial adjustment cap – This represents the interest rate limit on the first adjustment after the fixed-rate period is up. A cap of five, for instance, would mean that the new rate can’t go up any more than five points at the first rate adjustment compared to the original rate.

Subsequent adjustment cap – This represents the cap for each subsequent adjustment that the rate can rise over the rate during the first period.

Lifetime adjustment cap – This represents the limit on how much the interest rate can rise over the life of the mortgage.

It should be noted that some ARMs may cap the limit on how much your monthly payment increases, but not necessarily the limit on the interest rate. In this case, you could be stuck with payments that don’t cover the entire interest amount that’s due on your home loan.

Instead, whatever interest payment amount outstanding will be added to your total debt amount, leaving you stuck paying interest on top of interest and making your mortgage more expensive than it was when you first started paying it. These are known as “negative amortization loans.”

Before you take out an ARM, be sure to compare rate caps when comparing home loans. Two different loans might have the same rate during the initial period, but different rate caps can play a key role in which one would be more affordable. In addition, it’s important to determine the highest payment that you could end up paying on a mortgage before signing on the dotted line.

How Often Can Your ARM Loan Adjust?

Once the fixed-rate period expires on an adjustable-rate mortgage, the loan adjusts on a regular basis. While an annual adjustment tends to be typical, the adjustment period can be longer or shorter. It’s important for you to determine the frequency of your loan adjustments in order to more accurately budget for your mortgage payments.

The Bottom Line

There is definitely some appeal to adjustable-rate mortgages since their initial interest rates tend to be lower than fixed-rate mortgages. On the other hand, fixed-rate loans offer the benefit of remaining constant throughout the loan term, making monthly payments much more predictable and allowing borrowers to budget more easily. Before you make your decision, be sure to closely assess your financials and the current market, and speak with a seasoned mortgage professional who will be able to guide you in the right direction.

INFOGRAPHIC: 14 Real Estate Terms All Buyers Should Know