Fixed vs. Adjustable Rate Mortgages
When shopping for a new home loan, it’s important to understand the different types of mortgages and how they work. Here’s a quick overview:
Fixed-rate mortgages
The interest rate and monthly payment on a fixed-rate mortgage stays the same for as long as you keep the mortgage. Choose a fixed-rate mortgage if you want the security of a stable monthly payment. If you think that interest rates may rise, for instance, or you don’t want the worry of a changing payment than a fixed rate mortgage could be right for you. In return for stability, fixed-rate mortgages generally have slightly higher interest rates than adjustable-rate mortgages.
Adjustable-rate mortgages
An adjustable-rate mortgage, on the other hand, has a variable interest rate and monthly payment. Because you are assuming more of the risk, adjustable-rate mortgages generally have a lower interest rate. Choose an adjustable-rate if you want the benefit of a lower payment and can stomach the changes in your monthly payment. Adjustable-rate mortgages can be a good option in a falling rate environment.
A hybrid mortgage
This type of mortgage combines aspects of both fixed and adjustable-rate mortgages. Hybrid mortgages offer the lower initial interest rate of an adjustable-rate mortgage with the (temporary) stability of a fixed rate. A hybrid mortgage offers an initial period of fixed interest and monthly payments, usually 1, 3, 5, or 7 years, before converting to an adjustable rate. This type of loan may be a good option if you plan to only be in your home for a few years.
A note of caution
Be sure to read the fine print on your adjustable-rate mortgage to check the rate caps – the amount your interest rate can rise in any given adjustment period and over the life of the loan. Lifetime caps are required by law. For instance, if your initial rate is 5 percent, your interest rate might be capped at 2 percent a year, with a lifetime cap of 6 percentage points. This means that you could end up paying 11 percent interest. Do the math and make sure you are comfortable with the risk, and can afford the monthly payment, of the worst possible scenario.
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