Fixed Rate Versus Variable Rate Mortgage
FIXED OR VARIABLE RATE MORTGAGE LOAN: WHICH IS BETTER?
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Taking out a mortgage loan? While there are several types available, 2 of the most popular are the Fixed and the Variable Rate mortgage loans.
Which is better? Read on to find out what will work best for you.
Let’s Break Things Down
What is Fixed-Rate Mortgage (FRM)?
As the name implies, a fixed-rate mortgage is one that has an interest rate that does not change for the entire term of the loan.
With a fixed-rate mortgage, the principal (the amount borrowed) and the total monthly payment of interest rate remain the same from month 1 until the loan is paid.
Advantages of an FRM
Predictability and Stability. A fixed-rate loan allows you to accurately predict monthly payments for your mortgage and determine your budget with greater accuracy. And because the rate is fixed, monthly payments remain stable and protected from from rise and fall of interest rates.
Affordability in Times of Low Rates. A Fixed-rate mortgage is a good option for future homeowners and property owners when current rates are low and are predicted to rise in the coming years.
Easier to Understand. Computations for monthly payments are straightforward and relatively simple. This is good, especially for first-time homeowners.
Disadvantage of an FRM
Missed Opportunity for Savings. This presents the other side of the coin. Because monthly payments remain the same throughout the duration of your loan, it also means that when rates fall below the the fixed-rate you have agreed to pay, you cannot take advantage of having lower monthly amortizations.
When you want to benefit from falling rates, you may have to consider a refinance of your current loan. This means additional paperwork. More importantly, you may likely have to pay closing costs.
No Rate Break. The monthly payments for the first several years are typically more expensive for fixed-rate loans. Adjustable-rate loans allow for rate breaks on early payment interest amounts.
No Customization of Loans. An FRM is what you would call a cookie cutter loan and will tend to be almost identical from lender to lender. This means you cannot customize it depending on your unique situation.
What Is An Adjustable-Rate Mortgage (ARM)?
According to Investopedia, leading source of financial content on the web, an Adjustable-Rate Mortgage is “a type of mortgage in which the interest rate applied on the outstanding balance varies throughout the life of the loan. Normally, the initial interest rate is fixed for a period of time, after which it resets periodically, often every year or even monthly.”
What does this mean? Your monthly payments can increase or decrease based on prevailing interest rates. This may sound quite risky given that interest rates are beyond your control.
Advantages of an ARM
Low Interest Rates for an Initial Period of Years. Initial rate for an ARM is usually less than the rate on a fixed-rate mortgage. Because of this inherent characteristic, an ARM can potentially save you thousands of dollars at the beginning of the mortgage term.
Potential for Savings. When prevailing interest rates drop, an ARM presents opportunity for savings on your monthly amortizations.
On the other hand, when rates are relatively high, you get a chance for lower payments without refinancing when rates eventually drop.
Disadvantages of an ARM
Volatility. Once the introductory period ends on an ARM, your monthly amortizations will largely be dependent on market interest rates. Interest rate spikes can be problematic, especially if the amount borrowed is large.
The larger the amount borrowed, the more a change in interest rate will affect the monthly payments. In a worst-case scenario, elevated interest rates may make mortgage payments so unaffordable that a homeowner or property owner defaults that result in a foreclosure.
More Complicated. Because of accompanying risks, an ARM can be more complicated. You need to have a better understanding of the market to take advantage of the changes in rates. If you are a first first-time owner, this might not be something you would like to undertake.
Fixed Or Variable Rate Mortgage Loan: Which Is Better? How to Choose?
So, what really is the better option? Based on the discussion above, there is no black and white answer. Your choice largely depends upon your unique situation and financial flexibility.
What are to factors to consider that would affect your choice:
How long will you keep your property?
If you plan to stay in the home you intend to purchase long-term, a fixed-rate mortgage may be the wiser choice.
However, if you are planning on staying in your new home only for a few years, an ARM may be a good choice. Especially if you are planning to sell before the adjustable rate starts, you are not exposed to the risks of interest rate spikes. An ARM is likewise a preferable choice should you plan to pay off your loan in a short timeframe, such as 10 years or less.
Your financial flexibility
You might want to go with an ARM if you prefer to take advantage of the maximum possible savings but have the financial flexibility to take on higher monthly amortizations and total interests should there be a rise in interest rates.
As an experienced residential real estate agent in Murrieta, Mike Kish will find you the perfect home, and can recommend a trusted mortgage broker.
Call me at (951) 473-4069 and we can discuss your options.
For further information on mortgages, you might want to read the article on Private Mortgage Insurance
Tags: fixed rate mortgage, adjustable rate mortgage, ARM, FRM, first time home buyer, buyers agent, mortgage loan, loan rates, mortgage rates