New neighbors Bob and Sam moved onto a quiet block in South Minneapolis around the same time in 2004. Their homes, which sit across the street from one another, are close in value—each sold for about $200,000—and both Bob and Sam made a 10% down payment.
About ten years after moving in, Bob and Sam began chatting about their homes at a neighborhood barbecue. The subject of mortgage payments came up, and Bob was floored to learn that Sam’s were considerably less. In fact, after punching in a few numbers on his calculator, Bob realized that over the course of the last decade, he had paid almost $24,000 more than Sam on interest and principal payments.
How did Sam get so lucky? When he bought his home in 2004, he opted for an Adjustable-Rate Mortgage (ARM) instead of the standard fixed-rate mortgage. This meant that his interest rate varied over the last ten years, starting out low but increasing over time. Bob, on the other hand, signed a 30-year mortgage with a fixed rate. His payments have remained the same every month since he moved in.
Fixed-rate mortgages like Bob’s are the standard for most people, and for good reason: a reliable, consistent payment each month over the life of the mortgage can save you a lot of fretting over whether you’ll be able to make ends meet if rates go up. But they really only pay off if you intend to keep your home for the life of the mortgage—in most cases, 30 years. But these days many homeowners switch things up and move to a new house every decade, so a fixed rate that is calculated for three decades doesn’t really make good financial sense for everyone.
When Sam moved to South Minneapolis in 2004, he knew he wasn’t going to stay there more than 10 years. He was also financially comfortable enough to accommodate fluctuating mortgage payments, and when he did save money he applied it right back to the principal balance. So an ARM was the right choice for him—had he stayed in his home for 30 years, his adjustable rate would have risen above the fixed rate and cost him more money over the long term.
But don’t feel too sorry for Bob just yet—he plans on enjoying his home until after he retires. At that point, the fixed rate will have paid off, and until then, he doesn’t have to worry about his payments going up each month. So in this case, both Bob and Sam made the right choices for themselves in the end.
If you’re ready to buy a home, ask yourself: How long do I plan on staying here? Can my budget withstand fluctuating payments? What is the current interest rate? With a little foresight and financial planning, you can rest easy knowing that you chose the right mortgage for you.