If applying for a home mortgage loan, borrowers can choose one of several options. Common mortgage options include a fixed rate mortgage and an adjustable rate mortgage. With an adjustable-rate mortgage, the interest rate can adjust or change in scheduled intervals. Although risky, adjustable-rate mortgages have low initial rates, which can benefit borrowers who want to keep their payments as low as possible. For those who prefer predictability and stability, a fixed-rate mortgage is a better option.
A fixed-rate mortgage is a home loan with an interest rate that does not change over the life of the loan – regardless of market changes. With an adjustable-rate mortgage, house payments can rise or fall with each rate adjustment. If interest rates spike sharply, this can trigger a huge payment increase and impact affordability for some homeowners. A fixed-rate mortgage alleviates this headache and keeps house payments predictable for the duration of the mortgage loan.
While the most common option is the 30-year fixed mortgage rate, mortgage lenders offer other options, including the 15-year fixed-rate mortgage and the 10-year fixed-rate mortgage. The latter two options feature higher monthly payments, but are ideal for borrowers who want to build equity sooner and pay off their mortgages early, Additionally, borrowers who choose either a 10-year fixed-rate mortgage or a 15-year fixed-rate mortgage pay less interest over the life of their loans.
Borrowers who choose to spread their fixed-rate mortgage over 3o years enjoy lower home payments. This increases affordability, as well as their buying power. A lengthier mortgage results in higher interest payments, however, borrowers can usually write off mortgage interest on their tax returns. Some balk at the idea of paying on a home loan for 30 years, yet there are benefits to spreading out home loan payments. This frees up cash for borrowers, wherein they can invest the extra money in personal savings or their retirement.
While a 30-year fixed mortgage rate offers lower monthly payments, borrowers who select this mortgage option earn equity at a slower rate in comparison to 10 or 15-year mortgages. This is primarily due to the higher interest payments, and the fact that the majority of payments in the early years go toward paying down the interest, not the principal.
And since the interest rate is fixed, the rate on the mortgage remains the same even if market rates drop. To take advantage of a lower interest rate, borrowers with a fixed-rate mortgage have to refinance their mortgages. This involves completing a new home loan application, resubmitting income information and re-qualifying for the mortgage. Plus, there’s the cost of getting a new mortgage loan – application fee, credit report fee, title search fee, appraisal and other closing costs.
When applying for a home loan and deciding whether a fixed-rate mortgage is the best choice, borrowers should consider how long they plan to live in the house. If they plan to live in the home for several years, a fixed-rate mortgage is probably the best option. But if they plan to sell the home within the next five years, they can explore adjustable-rate mortgages and take advantage of the low initial rate. The initial rate period on an ARM is typically three to five years, in which short-term borrowers can sell before the first rate adjustment.