Without a doubt, the two most popular types of home mortgages are fixed rate mortgages and adjustable rate mortgages. The fixed rate mortgage is the original belle-of-the-ball. But the adjustable rate mortgage is no shrinking violet, and has it’s share of adoring fans. So, in this article, I’ll take a closer look at the fixed vs adjustable rate mortgage and you’ll learn when it’s best to choose one over the other.
Fixed Rate Mortgage
By some estimates, approximately 75% of all mortgage loans have fixed interest rates. This means, for example, that if your loan rate is 6%, it’ll be that way for the next 10, 15, or 30 years, depending on the length you’ve chosen.
Now, there’s not a whole lot that you can do about it, but did you know the fixed interest rate you get on your loan is inflated? You see, lenders don’t know what’s going to happen in the next 20 or 30 years. But they’ll assume that rates will increase. So just to hedge their bets, they will inch up the rate you get by a little bit. That’s why you’ll notice that mortgage rates will differ among the various lenders.
Conversely, adjustable rate mortgages start with rates that are lower than their fixed cousins. That’s because the terms of the loan will give lenders the flexibility to increase the rate over time. The flexibility is built into the loan agreement.
But this little fact shouldn’t discourage you from getting a fixed rate mortgage. It’s just the way the financial world works. Here’s a list of reasons when getting a fixed rate mortgage makes the most sense.
Get a fixed rate mortgage if…
– You like the idea of having your mortgage payments being the same amount over the life of the loan. Having equal predictable installments is good for budget planning.
– You have a pretty good idea of what your annual income will look like over the long term. By knowing this, you’ll feel more comfortable about buying a home that might initially stretch your budget.
– You’ve found a home that will adequately accommodate your family’s needs for now and in the future, and you don’t foresee moving for many years.
– You can afford the monthly payments without any problem. Just keep in mind that you should still have a big enough cushion that will allow you to put money away for your retirement or to cover other major needs, such as a car.
Adjustable Rate Mortgage
The adjustable (or variable) rate mortgage came to prominence in the 1980’s. Back then, it was commonplace to see fixed interest rate mortgages in the 13% or higher range! As you might guess, such hefty rates made it difficult or out of reach for many people to buy a home. So the adjustable rate mortgage was born.
For these type of mortgages, lenders will offer a very low introductory or teaser rate. But the terms allow the bank to gradually increase it over a number of years up to a maximum percentage. For example, the starting rate might be 2.5% and cap at 7.5%. The terms might also state that the rate cannot rise by more than 1.5% per year.
Now, it is possible for your mortgage rate to go down if other economic interest rates are falling, but don’t expect this to happen often. Nevertheless, get an adjustable rate mortgage if…
– You’re a real estate investor and planning to flip the home for a profit in a few years.
– You’re newly married and want to buy a small starter home that you will eventually sell in a few years to buy a larger home for a growing family.
– Your income is not quite sufficient to afford the home at the fixed rate, but you foresee solid increases in your salary over the coming years.
– You’re not sure if you will remain in a particular area or neighborhood for more than several years. Having a low adjustable rate allows you the opportunity to keep your payments low until you can decide whether you’ll move, or stay long term and perhaps switch to a fixed rate mortgage.
So in the fixed vs adjustable mortgage debate, the one you choose will depend on your personal financial situation and lifestyle goals. That’s why it’s important that you think long and hard about your short and long term reasons for locking into one mortgage or the other.
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