Bread and butter of the American home loan industry. Just about everyone has a fixed-rate mortgage, and the majority of people say that it’s definitely the way to go. In this article, we’re going to cover the things that you really need to know about fixed-rate mortgages to help you decide if you want to get a typical fixed-rate or if you want to go out of the box a little bit on something else.
A Fixed-Rate Mortgage is Your Most Expensive Option
Fixed-rate mortgages are very expensive to get. Closing costs on a fixed-rate mortgage are much larger than they are on an ARM loan, interest rates are usually higher on a fixed-rate than on an ARM, and the amortization schedule on a fixed-rate means that your interest payments are a huge percentage of your monthly payment at the beginning of the loan. On a 30-year fixed with a 4.25% interest rate, if your principal+interest payment is $950, the portion of it going to the principal at the beginning is going to be between $200-$250. When you consider that it’s between year 10 and year 15 that balance shifts so that you’re paying the principal more than the interest, and that the average American either refinances or moves every 3.6 years, you can make very little progress and build very little equity in your home even over a long period of time. There are some nice things about fixed-rate mortgages, but don’t let people convince you that there isn’t a significant cost for those benefits.
Fixed-Rates are Very Predictable
The term ‘fixed-rate’ refers to the interest rate on the loan, in that it is fixed throughout the entire loan term. Much of the reason why fixed-rates are so expensive to get is because lenders want to compensate for the chance that interest rates (or inflation) may rise above what the interest rate on your home is, and that puts them in a less favorable position. If you want to budget, and you want to know what your monthly payment definitely will be for as long as you want it to be, fixed-rates make planning for the future very straightforward. Granted, you pay a very high price for this convenience. The real value in fixed-rates is that they protect you from the possibility of rising interest rates in the future. However, you should keep in mind that rising interest rates are only a possibility, and if and when they do come, they could be 10 to 15 years down the road.
A 30-year Fixed-Rate Mortgage Should Not be Your Default Choice
Did you know that many developed countries have laws against 30-year fixed-rate mortgages? Seriously, it’s because the cards are stacked so highly in the lenders’ favor. Depending on your interest rate, you can easily pay as much in interest over the life of the loan as the amount your house was sold to you for. The first things you should look at are the terms you can get on an ARM loan. Interest rates on a conventional ARM are usually at least a full percent below a 15-year fixed, and 1.5% below a 30-year fixed, sometimes more. ARM loans are also fixed for the first 5 years, which means you skip out on the period of the loan that you’re paying the most interest. If ARM rates aren’t significantly lower than fixed rates, and you don’t want to take the risk, your next choice should be to look at a 15-year fixed. You can get a lower interest rate on a 15-year than a 30-year, and save a boatload of money in interest over the life of the loan. Only move from a 15-year to a 30 if you cannot afford the higher monthly payment on a 15-year. Scrimping and saving to manage the payment on a 15-year is usually worth it in the long run.
There’s a lot more to know about fixed-rate mortgages, but the above is really all you need to know. Fixed rates are more expensive both in the short term and usually the long term than an ARM, fixed-rates are much more predictable than an ARM and can be worth it for a person looking for that reassurance, and a 30-year fixed should never be your default choice.