Variable Vs Fixed Rate Loans - Fixed rate mortgages and adjustable rate mortgages (ARMs) are the two main types of mortgages. Although the market offers many types of these two types, the first step when buying a mortgage is to determine which of the two types of loans best suits your needs.
A fixed rate loan charges a fixed interest rate for the duration of the loan. Although the principal amount paid each month varies by payment, the total payment remains the same, making it easier for homeowners to budget.
Variable Vs Fixed Rate Loans
The partial schedule below shows how the principal and interest payments change over the life of the mortgage. In this example, the mortgage term is 30 years, the principal is $100,000, and the interest rate is 6%.
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As you can see, the payments made in the early years of the mortgage include interest payments.
The main advantage of a fixed rate mortgage is that the borrower is protected from a sudden and possible large increase in the monthly mortgage payment if the interest rate increases. Fixed line mortgages are easy to understand and vary slightly from lender to lender. The downside of a fixed rate loan is that when the interest rate is high, qualifying for a loan is more difficult because the payments are more affordable. A mortgage calculator can show you the effect different rates have on your monthly payment.
Although the interest rate is fixed, the total interest you pay depends on the term of the loan. Traditional lending institutions offer fixed-term loans in a variety of terms, the most common being 30, 20, and 15 years.
A 30-year mortgage is the most popular option because it offers the lowest monthly payments. However, the exchange of these lower funds has a higher overall cost, because the additional ten years, or more, of this period are usually reserved for interest payments. The monthly payment for a short-term loan is higher so that the principal is paid in a shorter time. Also, short-term loans offer lower interest rates, which allows more money to be paid on each loan. Therefore, short-term loans cost less in general. (For more, see Understanding Loan Payment Structures.)
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The interest rate on an adjustable rate mortgage is variable. The initial interest rate on an ARM is set below the market for similar fixed-rate loans, and then the rate rises over time. If the ARM is held long enough, the interest rate will be higher than the fixed rate mortgage payment.
ARMs have a fixed period of time in which the initial interest rate remains the same, and then the interest rate adjusts at predetermined intervals. The term of a fixed rate can vary greatly - anywhere from one month to 10 years; Shorter fixing periods generally carry lower initial interest rates. After the initial period, the loan is reset, meaning there is a new interest rate based on the current market rate. This is then the status quo until the next reset, which could be next year.
ARMs are more complicated than fixed rate loans, so knowing the pros and cons requires understanding basic terminology. Here are some considerations borrowers need to know before choosing an ARM:
The main advantage of an ARM is that it is cheaper than a fixed mortgage, at least for the first three, five or seven years. ARMs are also attractive because their low down payments often allow the borrower to qualify for a larger loan, and, in a low-interest rate environment, allow the borrower to enjoy lower interest rates (and money- lower payments) without the need to refinance the loan. .
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A borrower who chooses an ARM can save several hundred dollars a month for up to seven years, during which the costs may increase. The new rate will be based on market rates, not the lowest market rate. If you are very lucky, it may go down depending on how the market rate is at the time of the reset rate.
ARM, however, can present significant limitations. With an ARM, your monthly payment may change regularly throughout your life. If you take out a large loan, you may face problems when interest rates rise: Some ARMs are designed so that the interest rate will almost double in a few years. (For more, see
Indeed, adjustable rate mortgages emerged from many financial planners after the mortgage meltdown of 2008, which ushered in a period of foreclosures and short sales. Borrowers experienced sticker shock when their ARMs were revised, and their payments skyrocketed. Fortunately, since then government regulations and laws have been put in place to increase oversight which turned the housing bubble into a global financial crisis. The Consumer Financial Protection Bureau (CFPB) has been cracking down on predatory mortgage lending practices that harm consumers. Lenders lend to borrowers who are likely to repay their loans.
When choosing a loan, you need to consider various personal factors and balance them with the financial realities of the changing market. People's personal finances go through periods of ups and downs, ups and downs in interest rates, and ups and downs in economic strength. To choose your mortgage in context, consider the following questions:
Should You Choose A Fixed Vs. Variable Rate Mortgage?
If you are considering ARM, you should run the code to determine the worst case. If you can still afford it if the loan is refinanced at a higher rate in the future, an ARM will save you money every month. Ideally, you should use savings compared to a fixed-rate loan to pay extra principal each month, so that the total loan amount is reduced when refinancing is done, further reducing costs.
If interest rates are high and expected to fall, an ARM will ensure that you receive the maturity benefit, as you are not locked into a fixed rate. Whether interest rates are rising or stable, predictable payments are important to you, and a fixed-rate loan may be the way to go.
An ARM may be a better option if lower payments in the near term are your primary need, or if you don't plan to live in the home long enough for the value to increase. As mentioned earlier, the term of a fixed ARM rate varies, usually from one year to seven years, which is why an ARM may not make sense for people who plan to keep their home longer. that. However, if you know that you will be moving in a short period of time, or you don't plan to keep the house for decades to come, then an ARM will make a lot of sense.
Let's say the interest rate environment means you can take out a five-year ARM with an interest rate of 3.5%. A 30-year mortgage, by comparison, can pay an interest rate of 4.25%. If you plan to move before the five-year ARM resets, you'll save a lot of money in interest. If, on the other hand, you end up staying at home for a long time, especially if rates are high while your loan is changing, then a mortgage will cost more than a fixed rate loan. However, if you're buying a home with the goal of getting a bigger home when you start a family — or you think you're moving for work — then an ARM might be right for you.
Solved A Loan Officer Compares The Interest Rates For
For people who have a steady income but don't expect it to grow quickly, a fixed income mortgage makes a lot of sense. However, if you expect to see an increase in your income, going with an ARM can save you from paying more interest in the long run.
Let's say you're looking for your first home and you've graduated from medical or law school or you've got an MBA. Chances are you'll earn more in the years to come and be able to pay off the increased payments when your loan is repaid at a higher rate. In that case, ARM will work for you. In other cases, if you expect to receive money from a trust at a certain age, you can get an ARM that resets the same year.
Taking out an adjustable rate mortgage is more attractive to home borrowers who have, or will have, the money to pay off the mortgage before the new interest rate begins. Although this is not the case for most Americans, there are some cases. Which may be easier to remove.
Take a lender who buys a home and sells another at the same time. That person may purchase a new home while the old one is still under contract, and as a result, will take out an ARM for one or two years. Once the lender receives the proceeds from the sale, they can turn to the ARM repayments with the proceeds from the sale of the home.
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Another situation where an ARM can make sense is if you're able to accelerate the monthly payments enough to pay them off before they restart. Using this strategy can be dangerous because life is unpredictable. While you may be able to make a quick payment now, if you get sick, lose your job, or the heat goes out, that may not be an option.
Regardless of the type of loan you choose, choose it
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