Understanding Fixed vs. Adjustable Rates for Homeowners
Getting to the Differences, Benefits, and Drawbacks of Various Mortgage Types
If you’re just getting ready to pre-qualify for your first home loan, or if you’re re-entering the housing market for the first time in a long time, getting your head wrapped around your loan options can be a tricky affair. One of the key basic differences in mortgages is the distinction between a fixed-rate mortgage and an adjustable-rate mortgage.
If you want to get super basic about it, the difference between a fixed rate and an adjustable rate mortgage is pretty simple. With a fixed rate, your interest rate on the mortgage never changes. From the moment you take out the loan until you pay it off, refinance, or sell the home, it stays the same. With an adjustable rate mortgage, the rate can change. But that is an oversimplification, of course, and as the saying goes, the devil is in the details.
The Basics of Fixed-Rate Mortgages
Fixed-rate mortgages, according to the experts at Bankrate, are the most common type of home loan taken out in the United States. With a fixed rate mortgage, your interest rate is determined at the time you take out the loan and it never changes.
Interest rates are determined by a number of factors, including your credit score, where the home you are purchasing is located, the price of the home, and the size of your down payment, and how long the term of the loan lasts.
The Benefits and Drawbacks of Fixed-Rate Mortgages
For many borrowers, especially those who are looking to maximize the amount of home they can buy on a budget, fixed-rate mortgages are very attractive. They allow homeowners to finance more of a home over either a shorter (15-year) or longer (30-year) period of time with the assurance that no matter what happens with the economy, their payments will not go up. This is true except in cases where their property taxes, homeowners association fees, or insurance premiums go up.
Unfortunately, fixed-rate mortgages also have their downside. Borrowers selecting a fixed-rate mortgage generally pay a higher interest rate than those going with adjustable rate mortgages or ARMs. Fixed-rate borrowers also pay a higher monthly payment than those with an ARM.
Adjustable Rate Mortgages
Adjustable rate mortgages are less common than fixed-rate loans and provide the borrower with less security. They are typically for a thirty-year period and may offer a period — at the beginning of repayment — with a low fixed rate, before switching to periodically adjusting based on whatever index they may be pegged to. Adjustable rate mortgages usually have a cap to how high the rate (and mortgage payments) can go.
The Benefits and Drawbacks of Adjustable Rate Mortgages
Adjustable rate loans offer borrowers a lower initial monthly payment. This can be very attractive to younger people who presumably will earn more and more money over the life of the loan. Adjustable rate loans also offer lower general interest rates and, therefore, lower monthly payments than fixed-rate loans. This allows borrowers, in many cases, to pay less in interest over the life of the loan.
Unfortunately, these savings, both initially and potentially over the life of the loan, also come with a bit of risk. It doesn’t take a great deal of hindsight to look back a decade to a moment in our nation’s history when many homeowners with adjustable rate mortgages found themselves in a position where they could no longer afford their monthly payments, and hence, their homes.
Deciding What’s Best for You
In the end, you will have to decide whether a fixed rate or adjustable rate mortgage is the best fit for you, because both have their benefits and drawbacks. Take the time to fully research your options and speak with financial planning professionals so that you make the best decision for your life circumstances.