Fixed or Adjustable: Which Mortgage is Right for You?
Buying a home is a significant accomplishment in your life. As you’re determining the floor plan and amenities you want in your California home, spend some time contemplating your mortgage options.
Lenders offer two basic types of mortgages, fixed-rate and adjustable-rate. While you may find different loan options within those two categories, your first decision is choosing whether you want a mortgage with an interest rate that never changes or one that starts low and varies over time, either up or down.
Fixed-Rate Mortgages: Predictability
When it comes to budgeting, you know what you get with the fixed-rate mortgage. You will lock in an interest rate that will never change during the term of your mortgage. If you’re borrowing during times of low interest rates, this is a valuable perk because you’ll pay less money in interest.
With a fixed-rate mortgage, your monthly total amount paid for principal and interest will not change. (However, if your municipality increases taxes every year as most do, you will see an increase in your monthly payment if you’re paying your taxes through your mortgage payment and not separately.) Due to amortization, more of your payment will go toward interest in the first years of your mortgage; in the latter stages of your mortgage term, more of your monthly payment will go toward principal.
There are no surprises with a fixed-rate mortgage, so it’s easier to figure out your monthly allocation for housing. But if you’re borrowing during a time of high interest rates, this mortgage’s payments might be unaffordable.
Another factor to consider with a fixed-rate mortgage is the term. Thirty years is the most popular option because it offers the lowest monthly payment. However, you’ll pay more for your home over the life of the mortgage compared to a 15-year or 20-year term because you’re paying 10 or 15 additional years of interest. A shorter term mortgage carries a higher monthly payment but will be repaid in a shorter period of time.
Fixed-rate mortgages work for you if…
- You want to know what you’re going to pay every month.
- You plan to live in the house for 10 years or more.
- You’re borrowing during a period of low interest rates and the first two points apply to you.
Adjustable-Rate Mortgages: Flexibility
An adjustable-rate mortgage (ARM) offers attractive features for some borrowers. The interest rate for these mortgages will adjust frequently over the life of the loan, possibly monthly or yearly, depending on how the mortgage is structured.
In the early stages of the ARM, your interest rate will be lower than the lowest rates offered on a fixed mortgage. Depending on market conditions, your ARM can increase sharply or gradually or it could decrease. It’s uncertain, which is why it’s important for you to determine that you can afford larger monthly payments if your mortgage adjusts upward.
Along with lower initial payments, you also can qualify for a larger loan because you’re not paying as much in interest at the start. If interest rates continue to decrease, you’ll enjoy lower mortgage payments and lower rates without refinancing your mortgage.
There is an interest-rate ceiling that your ARM never will surpass, and that ceiling will vary by lender. Your interest rate will adjust based on activity of a particular index, such as interest rates on certificates of deposit or Treasury bills. Keep in mind that interest rates on ARMs can double within a few years.
Adjustable-rate mortgages work for you if…
- You want an initial rate that starts below current market rates for fixed mortgages.
- You plan to live in your house for approximately 5 years or fewer (or before the fixed-rate period ends).
- Interest rates are relatively low now and you believe they could go lower in the future.
Buying a home in the Bay Area and Silicon Valley is an exciting opportunity. Make sure you choose the proper mortgage to suit your needs.