As the volatility in mortgage rates increases, the decision regarding whether to choose fixed mortgage rates or adjustable tax rates has become a crucial one. The decision goes beyond just the present, and can affect your financial stability for decades to come which is why the great importance must be placed in understanding in detail the intricacies behind choosing one option over the other, and how they correlate with your long term objectives.
Understanding Fixed-Rate Mortgages
For home buyers, a fixed mortgage is always a good option as it allows them to have a steady interest rate for long even in an unpredictable economy. Fixed-rate loans have a set interest rate that lasts throughout the life of the loan without fail. The most popular terms for fixed-rate mortgages are 15 years and 30 years. The beautiful aspect about this is that one can always rest easy knowing that his or her monthly principal and interest payments will never increase regardless of economic changes and instability in the market.
For instance, a month’s worth of payment totaling $1,896 will remain the same throughout 30 years if you take out a fixed mortgage for $300,000 with 6.5% interest (for taxes and insurance, these costs are outside). However, the main disadvantage of fixed mortgages is that they have higher interest rates than initial variable rates due to the inflation and depreciation of collateral for fixed mortgages.
The Variable Rate Alternative
Variable-rate mortgages are generally cheaper, but the rates are adjusted according to the mortgage rates which change annually, for example, a 5/1 ARM allows the rate to be fixed for the first five years linked to a prime rate, after which it is updated every year. These mortgages are especially attractive to homebuyers who want their payments to be comparatively lower at the beginning and who anticipate a change in their future housing plans.
Imagine that you’re trying to get a loan to buy a house. In a scenario where you want to buy a house worth $300,000, consider this: You have the option of going for an adjustable rate mortgage. You’d start off on a rate of 5.5% which would increase after five years or be subjected to market rate fluctuations. The monthly payment in this case would be $1,703. This shows that if I have a fixed rate mortgage, there is a risk that after five years, I may end up paying a much higher payment if the market rate does end up increasing.
So what are the impacts of my Decision
So the difference is $193 which means over five years I have a loss of $11,580 if I take an ARM in comparison to a fixed loan. But if I am assuming after a fixed time period, the interest rates go up, does that mean the average rate on my ARM stays lower than the fixed loan? If the interest rates do increase by 2% then the arm payment comes down which effectively nullifies my $11,580 savings, which then makes the ARM an unfeasible option.
A difference of even 1% may cause me to pay for an additional few thousand right? For a payment of $2,009, it would take me two decades to break even on my savings, since I would not be making as much. To maximize your interest on a mortgage consider locking the rate for at least 30 years, or else the future increase in rates will work against your favor.
When to Pick What
A fixed rate mortgage should be selected when the following criteria are met;
- If you live in that house for a long period of time
- Current rates are low
- You choose safety over savings
- Living cost which includes payments is high so saving would be hard
- Housing prices are increasing
- Income is stable but does not have the potential to grow substantially
Variable rates work better if:
- You intend to sell or refinance prior to the adjustment of interest rates.
- You expect a drop in interest rates and are prepared to accept changes in payments.
- Your aim is to keep initial costs as low as possible and feel that your income will grow a lot in the future.
- You are a risk taker.
Market Timing and Economic Considerations
Research shows that, historically, economic conditions as well as Federal Reserve policy and inflation rates determine the direction of movements of mortgage rates. While it may not be possible to pick the best time to enter the market these cycles are useful to understand for making your decision. Sometimes if interest rates are increasing, it may make sense to set the mortgage rate as the rate is unlikely to go any lower. If interest rates are high, then there is an expectation that they will fall.
The correlation between the cost of a mortgage and property values reverberation is also of importance. States with high demand and expensive buying prices, low rates lead to price increases. And vice versa.
Beyond the Rate: Additional Factors to Consider
There are aspects that you need to keep in mind and not simply the rates when looking for a mortgage.
For example, how long you intend to hold the loan and your risk appetite, market conditions and your investment goals for the loan. Furthermore, any potential changes in your life such as relocation and having children can also be important. Finally, do also remember the total cost of the loan once you reach maturity.
Making Your Decision: A Strategic Approach
You should look at your circumstances from both a short-term and long-term perspective. Consider growth rates and then aspects such as the potential for rate tightening. Note that lowest rate won’t always be the best option as there is value is certain level of risk as well as consistency and assurance in your financial world. Create a comprehensive budget that will include expenses such as property taxes, insurance, upkeep of the property, and perhaps HOA dues. Estimating the potential impacts of different mortgage options on budgeting for retirement or children’s education would be essential as well.
When you do decide on fixed or variable loans, make sure you fully grasp the set terms including but not limited to adjustment caps, margins and indexes. Numerous inventory opportunities are out there but make sure to work with a financial planner who is able to recommend different options to help you achieve your desired financial goals.
Making the right choice of mortgage enables one to build a sound long term financial plan dealing with the intricacies of reasonable monthly payments and exposure to future market risk. You will come to the realization that there’s a lot more to deals in real estate by weighing your options factoring on the extent to which your finances are impacted at the time and when the investment matures. Bet Smart Be Smart.
