Fixed vs. Variable Rate Mortgage

A fixed rate mortgage is the preferred method to choose when seeking a mortgage. It is a personal decision based on either how quickly you want to pay off your mortgage, or how much you you can afford for a monthly payment. Some borrowers in their 40s and 50s like 15-year fixed mortgages so their home will be paid for when they retire. Some borrowers cannot be approved for a mortgage unless they accept a variable interest rate, which initially has a lower rate than a mortgage (and thus a lower monthly payment).

There are varying schools of thought on choosing mortgage terms. In almost all cases, generally, it's good to lock in "other people's money" at a favorable rate for the longest time period whenever possible. For example, if interest rates are very low and are expected to go up, try to lock in a large sum for a long period of time. Financial planners may use another approach: "if you can get a higher return somewhere else, borrow and then invest the difference." For example, borrow with a lower variable rate instead of a fixed rate, and then take the $100 or so less in payment per month and invest it where there is a higher return. This is extremely risky for the average person, as the "higher return" instrument is likely the risky and volatile stock market (or this money is just spent and not saved).

The same financial theory can be applied if you choose a 30-year fixed mortgage over a 15-year loan. That is, choose a 30-year mortgage with a smaller payment instead of a 15 year mortgage, then take the difference and save it in your 401k as an example.

Variable rate loans are known as ARMs, or Adjustable Rate Mortgages. An initial interest rate (lower than the current fixed rate) is set for a specific period of time, usually 5 years.  After the five-year period expires, the interest rate "resets," and then the prevailing interest rate is applied to your mortgage. Many people lose their houses when their loan resets, as interest rates may have increased a lot after the initial period. Thus, before applying an ARM, forecast your income for many years into the future and also be financially prepared when the interest rate adjusts.

Another consideration of mortgage selection are "points." Average published rates are most often for loans with sums greater than $100,000, and with a standard 20% for a down payment. Smaller or very large loans may have a higher rate, other fees, or "points." A point is an upfront, one-time fee, that equals 1% of the loan principle. Multiple "points" can be charged per loan, which must be taken into consideration. Both ARMs and fixed rate mortgages often require points, but many lenders offer no-points mortgages as an incentive for borrowers to choose their product.

Always seek professional financial advice before applying for a mortgage. 30 year fixed rate loans at the lowest rate is the most common and least risky choice for borrowers.

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