Fixed or Adjustable Rates?
Choosing fixed or adjustable is a function of how long you expect to live in the home and your tolerance for monthly payments increasing.
As the name implies, the interest rate on a fixed rate mortgage is set at the time you take out the mortgage and remains constant over the life of the mortgage. This means your monthly payment also remains constant and predictable, which can be reassuring to many buyers.
Alternatively, with an adjustable rate mortgage (ARM), the interest rate and monthly payments can change as interest rates change. The rate is fixed initially and is subject to being reset based on changes in interest rate benchmarks. The big benefit to the borrower is that usually ARMs have interest rates (at least initially) that are lower than the rates on fixed rate mortgages.
Adjustable rate mortgages are attractive because of their lower initial rate. Your risk is that your rate and monthly payment will rise in the future. If you are comfortable that you can accept an increased payment or if you think you will be moving in a relatively short time, the savings with an ARM can be substantial.
The impact of term length
Most institutions offer fixed rate mortgages of 30 years and 15 years. Choosing the term of a fixed rate mortgage is usually a function of what level of monthly payments you can afford and how anxious you are to pay off the entire mortgage.
Each monthly payment is comprised of interest and principal. Early on, most of your payment goes towards interest, and towards the end of the life of the mortgage, most of your payment goes toward principal, so most of the mortgage pay down comes late in the mortgage period.
The benefit of a shorter 15-year mortgage is that after 15 years you will have paid off the mortgage loan, and you own your home free and clear. You will also pay less interest over the life of the mortgage. The trade off is that your monthly payments will be higher.
|15 Year Mortgage||30 Year Mortgage|
|Total monthly payments over the term of the mortgage||$130,900||$187,791|
|Total principal paid over the term of the mortgage||$100,000||$100,000|
|Total interest paid over the term of the mortgage||$30,900||$87,791|