Fixed or Adjustable…Which is Better?
As you begin your journey of buying and financing your home, one of the first questions you’ll need to answer is which type of loan is best for you. Is a fixed rate better or should you consider an adjustable rate mortgage that comes with lower start rates? Let’s take a closer look at the advantages of both to help you make the right decision.
A fixed rate mortgage is pretty much easy to explain. The interest rate on the mortgage never changes throughout the life of the loan. This makes it easier to plan for both now and into the future. You’ll always know what your mortgage payment will be which in turn helps with financial planning as you move toward retirement. Fixed rates come in a variety of loan terms ranging from 10 to 30 years. You can get a fixed rate in 10, 15, 20, 25 and 30 year terms and the shorter the loan term the higher the monthly payment. The tradeoff with a longer term is more interest will be paid to the lender over the life of the loan.
An adjustable rate mortgage as its name implies is a loan that can adjust at some point in the future. These adjustments however follow guidelines clearly laid out in the note. An adjustable rate is set based upon an index, a margin and rate caps. A common index for most adjustable rate mortgages today is the London Interbank Offered Rate, or LIBOR and a typical margin for an adjustable rate mortgage is 2.00. If for example you have an adjustable rate mortgage and it’s getting ready to adjust based upon the terms of the note, your lender first looks up the index. If the LIBOR index were 2.00, the new rate would be 2.00 + 2.00 = 4.00% and will remain there until the next adjustment, typically one year away. To make sure there aren’t any wild rate swings from one year to the next, rate adjustments are limited by caps. If a cap is 2.00, that means no matter what the index at the time of adjustment may be, it can go no higher or lower than 2.00% of the previous rate.
Okay, so fixed or adjustable? If someone is buying a home and intends to keep it for the long haul, getting a fixed rate is probably the choice. If someone does not intend to keep the home over a longer period of time, then the lower start rate of an adjustable rate mortgage might make better sense.