When you are applying for a mortgage, one of the decisions you will have to make is whether you would prefer a fixed rate mortgage or one with an adjustable interest rate.
A fixed rate mortgage is exactly what it implies. The interest rate on the mortgage is fixed through the life of the loan. No matter how far up or down prevailing interest rates may go, your rate will always remain the same.
This can work to your advantage or to your disadvantage. If interest rates go up, you are protected. No matter how high rates go, your rate is locked in. If you bought your home within the last couple of years you were likely able to finance your mortgage at rates that were historically low. Since then, rates have been inching their way back up.
Homeowners with adjustable rate mortgages will see their monthly payments rise along with interest rates. Many of them who are already struggling to make their payments may find themselves having to sell their home.
But if you chose a fixed rate mortgage, you have protection against interest rate increases. Those historically low rates are locked in for the life of the loan. The higher rates go, the more money you are saving.
Of course the sword cuts both ways. If interest rates were to drop below your rate, you would be trapped in a higher payment. You can get out of the trap by refinancing at current rates. However, you will have to pay fees to do so and that may end up costing more in the long run. It all depends on how long you intend to remain in your home.
Also, fixed rate mortgages generally cost a bit more than adjustable rate mortgages since the lender is taking a greater risk, as interest rates could rise over the life of the loan.
You should also keep in mind that just because your interest rate is fixed, it doesn’t mean your payment won’t change. Most lenders also require you to pay extra into an escrow account that is used to pay your property taxes and homeowner’s insurance. If either of those go up, so will your monthly payment.
15 or 30? If you decide on a fixed rate mortgage, you’ll also have to choose a term. The most common terms are for either 15 or 30 years (though longer mortgages have started appearing in recent years).
Which one you choose will depend on your circumstances. Your equity will grow much faster with a fifteen year mortgage, and you will pay thousands of dollars less in interest. But your monthly payment will also be a lot higher since you have less time to pay it back.