Buying a house — especially your first house — is an extremely exciting venture. Joining the 64.2% of people who own homes in the US is a big step. It’s also a really scary one full of pitfalls.
There are so many decisions that you have to make. Make the wrong one and you could end up paying the consequences financially for quite a few years.
One of those decisions is which kind of loan you should take out. If you’ve done any shopping so far, you’ve probably already heard a bit about the fixed rate vs adjustable rate mortgage debate.
You should take a few moments to learn about the two types before you decide which one is right for you. That’s why we’ve put together this handy article. Keep reading to learn the differences between the two and the pros and cons of each.
Fixed Rate Loan
First, let’s take a moment and define what each type is.
A fixed rate loan is exactly what it sounds like. You get a locked-in rate at the beginning of your loan that doesn’t change for the duration of your loan.
If you buy at a time that interest rates are low, this can be a big advantage to you. You don’t have to worry about your interest rate going up even if the market rates go up. Plus, you have the certainty of always knowing how much your house payment is going to be.
Adjustable Rate Loan
An adjustable rate loan is not quite as straight-forward. The rate is adjustable according to market conditions.
That means that if interest rates go up, you’ll have a larger house payment to worry about. The flip side is that if they go down, you’ll enjoy a lower one. There’s always a certain amount of risk involved with taking out an adjustable rate loan.
Often you can find a sort of hybrid between fixed and adjustable rate loans. The loan may offer a fixed rate for a certain number of years. After that time the interest rate will begin to adjust according to market conditions.
Sometimes lenders will also offer a cap interest rate. This means that the interest rate will never go over a certain amount regardless of what the market does. That can provide you a little safety net, but be sure to read the fine print. The cap doesn’t always apply in all conditions.
Which One Is Right For You?
Now that you know what they are, how do you decide which one is right for you? Let’s take a look at some pros and cons and some scenarios when each loan type makes sense.
Fixed Rate Pros and Cons
The obvious advantage of a fixed rate loan is that you know it will never change. You don’t have to worry about your monthly payment ever going up.
The biggest advantage of fixed rates is also its biggest flaw. If market conditions dip considerably, you will be paying a much higher rate. The only way that you can take advantage of that dip in the market is to refinance.
This is not only a paperwork headache but also will cost you several thousand dollars in closing costs. Obviously, that puts a dent in whatever savings you might get from lowering your interest rate.
Fixed rate loans are also fairly standardized from lender to lender. There isn’t a lot of room for customization. The loan product either works for you or it doesn’t.
Adjustable Rate Pros and Cons
There’s a whole lot more wiggle room with adjustable rate loans. That can be a good thing or a bad thing depending on your circumstances.
A big advantage to adjustable rate loans is that the monthly payment, in the beginning, is very manageable. To attract borrowers, lenders offer adjustable rate loans with rock-bottom interest rates. Sometimes borrowers can even afford to qualify for a larger loan because the monthly payment is so easy to manage.
But…that can get you in trouble later on. Borrowers have to be careful not to bite off more than they can chew with an adjustable rate loan.
Remember, most loan terms last 15-30 years. You can’t know what the market will do in a few years and you could end up paying way more a month than you bargained for.
Adjustable rates are also very customizable. This can be great except that it also makes them very difficult to understand. Some have caps at a certain percentage, but the cap doesn’t apply to the initial adjustment.
Sometimes, the payments are so low at first that you’re not even covering all the interest. That means your loan amount is going up instead of down.
But, remember those hybrid options we talked about? Those involve a fixed rate at the beginning for a certain period of time.
What if you only plan to live in the home for that time period or less? Then, that attractively low up-front interest rate makes sense. If you move and sell the home before your fixed-rate period is up, you never have to worry about those market fluctuations.
Fixed Rate Vs Adjustable Rate: Pick Your Poison
What do you think? Have we made everything as clear as mud?
Deciding whether to choose a fixed rate vs adjustable rate loan is a big choice. Be sure to sit down with your lender and thoroughly go over your options. If you don’t feel like your lender is being honest and upfront with you, walk away.
A mortgage is a huge financial decision. You want someone you trust guiding you to make the right choice for you–not looking to line their own pocket.
If you need help finding a lender, don’t hesitate to reach out to us. As realtors, we’ve worked with a lot of lenders and we know who will be on your side. And of course, if you’re ready to start house shopping, we’re more than happy to help you find the home of your dreams!