Get to Know Fixed vs. Adjustable Rate Loans: Which is Right for You?
Fixed-rate and adjustable-rate home loans are two of the most common mortgages used today. But what exactly are the differences? What are the advantages and disadvantages? And which one is right for you?
Get to Know the Fixed-rate Loan
The fixed-rate home loan has been described as the “plain vanilla” of mortgages. There are no surprises or complicated math equations to figure out what you’ll be paying. The interest rate is fixed, plain and simple.
That means, whatever interest rate you have on the loan when you take it out from the lender will remain the same. Thus, your payments will remain the same, and you’ll know exactly how long you’ll be paying off the mortgage, usually 15 or 30 years. Think of this loan as the safe road—you know what to expect, but you may have to pay a price for that stability.
Get to Know the Adjustable-rate Loan
The adjustable-rate loan is, you guessed it, adjustable! This means the interest rate will be periodically adjusted based on this or that index that the lender chooses to use. The indexes are generally measures of how much it is costing the lender to lend to you based on what’s happening in the credit markets.
Adjustable-rate loans are a lot trickier because they vary so much! There are varying indexes that determine the interest rate, varying adjustment periods (the period where the interest rate remains unchanged, varying interest rate caps, etc. In general, adjustable rate loans work like this: you take out a loan with an interest rate, time passes, and that rate changes.
Pros and Cons of Both
Like we’ve already said, fixed-rate loans are safe. They’re predictable. No matter what happens in the credit market, they’ll stay constant. That’s really reassuring for a lot of buyer, especially first-timers.
But if rates fall significantly, people with fixed mortgages have to refinance, which is a lot more costly and time-consuming than having one’s rate adjusted. Also, there are no breaks with a fixed-rate loan, so for some buyers, the high initial cost of the loan plus down payments, closing costs, and moving costs are just not feasible.
Adjustable-rate mortgages, on the other hand, are often sold with an initial discount or low rates so that buyers can afford the loan. Lower rates are simple—you don’t have to do a thing! You just watch the rates drop and your mortgage payment get adjusted.
But what if rates skyrocket? or at least, go up? Adjustable-rate loans carry an inherent risk for this reason. Higher rates could mean much higher payments. Although you may pay less in the long run, adjustable loans have a degree of uncertainty.
Questions to Ask Yourself
1. How long do I plan to stay in the home? If you’re planning to move within a few years, and adjustable-rate mortgage makes more sense and could save you a lot of money. But if you’re in the home for the long haul, the fixed-rate might be a better idea.
2. What’s the timeline of the loan like? Adjustable-rate mortgages have a wide variance in adjustment periods. Think about what you can handle. If the loan will adjust on a monthly basis, that might be too volatile for your financial situation.
3. What are the current interest rates? We know the rates have been low, low, low for a long time. Fixed-rate mortgages are a great bet in this kind of lending environment. But if you’re getting a loan when rates are higher, an adjustable-rate mortgage might save you a lot up front.
4. What can I really afford? Fixed vs. adjustable is reward vs. risk. If you can afford to take a risk on an adjustable-rate loan, then do it! How do you know if you can afford it? If rates jump up, will you be able to cover your payment? If yes, you have nothing to worry about. If no, consider the safer route of the fixed-rate loan.
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