After you've scoured the classified listings online and offline to find the best real estate deals and you’re finally ready to buy a home, you now have to start thinking about how to finance your purchase. Most likely you will have to take out a mortgage, so now one of the most important questions facing home buyers is whether to go with a fixed or variable mortgage rate. Both options have their advantages and disadvantages and will have a huge impact on your monthly payments and the amount of interest you pay over the duration of your mortgage.
Fixed Rate Mortgage
As the name indicates, a fixed rate mortgage has an interest rate that does not change over the life of the loan. Usually these loans are over a 30 year span or sometimes a 15 year span. Unless you refinance, the interest rate will always stay the same regardless of any economic or market changes. If market interest rates rise, you don’t have to worry.
If you are buying a home that you believe you will live in for the rest of your life, then this is the mortgage loan for you. In the current market especially, the fixed rates have been very low and competitive. Having the rate “locked in” provides you with the peace of mind of a low and stable interest rate.
There are some potential drawbacks to borrowers however. Locking in your rate usually comes at a premium, so the interest rate is slightly higher whereas an adjustable rate is often discounted. Another drawback is that if there is a significant dip in the interest rate, a fixed rate borrower will not be able to take advantage. Currently however, most fixed rate loans are being priced equally or even lower than adjustable loans.
Adjustable Rate Mortgage
Just as a fixed rate never changes, an adjustable rate mortgage has a variable interest rate that changes throughout the life of the loan. These loans are ideal for people who only wish to make a short term investment or only plan on owning a particular home for a short period of time. They are attractive because they typically come with a lower initial interest rate than a fixed rate mortgage. After the initial fixed period of the loan, the rate becomes variable or adjustable, or you are able to refinance or even just sell the house completely.
The downside of an adjustable rate is of course if market interest rates rise then your interest rate will rise as well. Therefore this type of mortgage is very risky and insecure compared with the fixed rate.
Overall, a fixed rate mortgage is best for someone who wants a low risk, low hassle loan in order to pay for your home over the long haul. An adjustable rate is riskier with more variation but could be a good option for a short term investment or for someone who is market savvy. There are also many hybrid loans with some initial period with a fixed rate followed by opportunities to adjust the rate. An example would be a 5/25 ARM loan which means it’s a 30 year loan with the first 5 years fixed and the remaining 25 years adjustable. Take your time and consult with the professionals at the financial institution you're taking your mortgage at, to understand that is the best solution for you.