When you are applying for a mortgage, you will need to pick between a fixed-rate or adjustable-rate mortgage. These two different mortgage types are based on what kind of interest you will be paying over the life of the loan. Let us break down the differences between the two.
An adjustable-rate mortgage has a rate that can change over the life of the loan. This rate can change anytime in accordance with the adjustment period – the minimum length of time the lender must wait between each rate change. Typically, your credit union or bank will adjust your rate to the market rate at the end of each adjustment period. This means that your monthly payment amount can either go up or it can go down with the market rate. These increases and decreases can vary in size depending on how volatile the market is at the time. Typically, adjustable-rate mortgages are chosen when the interest rates are high and are expected to go down over time. This allows you to get the lower market interest rates without having to refinance your mortgage. However, it also means you will have to pay more if the markets go up instead.
In contrast to the adjustable-rate mortgage is the fixed-rate mortgage. A fixed-rate mortgage is a mortgage where the rate stays the same for the length of the mortgage. This is a good option for homeowners when the rates are low because it allows them to lock in that rate for a long time. However, it might not be the best idea when rates are high because you would have to refinance the mortgage to reduce the rate to take advantage of large market drops.
However, deciding on which option works best for you does not entirely depend on the market rate. It also depends on your individual financial situation. If you do not have the ability to handle an increase in the interest rate, monthly payment, over the foreseeable future, then a fixed-rate mortgage might be the best for you. If you do have the ability to handle rate fluctuations and the market seems relatively high, then an adjustable rate might be better for you.
Here is an example to illustrate the difference between the two, for a fixed rate loan the mortgage payment on a $300,000 home at 3% would be around $1,260 for the length of the mortgage*. If you had picked an adjustable rate on a mortgage of $300,000 that was 3% at signing and then jumped to 5% after the adjustment period, the monthly payment could change from $1,260 to $1,610*. This means you might need $400 extra in your monthly budget just in case for and adjustable-rate mortgage*. However, this can also work in the other direction where you might be saving an extra $400 a month if interest rates were at 5% during the signing and dropped to 3% after the adjustment period*.
It is always best to contact a financial lender to discuss and learn about all the options available to you.
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*These numbers and rates are used for illustrative purposes only, and in no way represent what a buyer will pay during closing. Contact a financial advisor for more information.