One of the most important decisions you will make when you purchase a home is whether to get a fixed or adjustable mortgage. Both loan types have advantages and disadvantages that you should understand before you choose.
The fixed-rate option is a good choice if you need stability. If the idea of your mortgage payment fluctuating makes you nervous, you will be more comfortable with a fixed-rate mortgage. This type of loan makes planning your budget easier because you know what your most expensive bill will be every month. Because the rate for the entire term of the loan is locked in at the beginning, fixed-rate mortgages cost more initially. However, if you plan to stay in your home for many years, you will be saving money by choosing a fixed-rate mortgage.
While homeowners with fixed-rate mortgages will not see their payments increase when market rates increase, they also do not get to automatically take advantage of falling rates. In order to lower your payment on with a fixed-rate mortgage, you have to refinance your loan.
If you are more interested in saving money during the first few years you live in your home than having a predictable mortgage payment, an adjustable rate loan is a good choice. The rate can adjust regularly, depending on the terms of the loan. However, the initial interest rate for an adjustable-rate mortgage is almost always lower than a comparable fixed-rate loan.
You will see the most benefits from an adjustable-rate mortgage if you buy your home or refinance when interest rates are high. When rates fall, your payments will drop in line with the index. While there is usually a ceiling for how high your rate can go, adjustable-rate mortgages typically do not limit how low your rate can drop. This kind of mortgage is also the best choice if you only plan to live in your home for a few years or if you need some time to improve your credit situation so you can qualify for a lower interest-rate loan when your fixed term expires.
Rates on adjustable rate mortgages almost always increase after the fixed-rate period expires. Adjustment frequencies vary from loan-to-loan so it is important to note when your rate will adjust. Some loans adjust every month after the initial period while others adjust annually. The cap will determine how high your interest rate can go.