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Fixed & Adjustable Rate Mortgages

Before I became a real estate broker, I was involved in loan processing. This is a great advantage to you as a buyer. For not only am I a good resource for buyers just getting started and who are nervous about this part of the process, but between the pending to close process, when the final steps are fast and furious, I can help keep things on track, and will navigate you through to close.

For example, because of my experience, I always avoid scheduling a closing for last week of the month and always avoid the last Friday of the month.  Because everyone involved in the transaction is slammed during that week, delays can happen which could result in your not getting the keys until following week. That is just not a chance I am willing to take, and therefore, we choose other dates.

Here is an overview which will provide you what you need to know if you are securing a loan:

Buyers can easily get overwhelmed by the options they are confronted with when it is time to apply for a loan. Conventional? Government-backed? Fixed rate? Adjustable rate? Even within these categories there can be several options.

Before you can determine which loan is right for you, you need to have an understanding of how each work and the costs and benefits of each. Let’s start with definitions:

Fixed Rate Mortgage

Interest rates on fixed rate mortgages remain fixed for the life of the loan. The monthly principal and interest payment stays the same, however if property taxes and homeowners insurance are paid as part of your payment, these are paid through an “escrow” account which can fluctuate from year to year.

Generally there are two terms for a fixed rate mortgage – 15 year and 30 year, although depending on the bank, there may also be 10 year and 20 year. The shorter the term, the lower the interest rate, but the monthly payment is higher, but you pay less over the life of the loan as in the following example for a $300,000 loan:

Monthly Payment Amount Paid Over Life of Loan
15 year fixed rate mortgage @ 4.25% $2,256.84 $406,230.34
30 year fixed rate mortgage @ 4.75% $1,564.94 $563,379.12

Adjustable Rate Mortgage

Adjustable rate mortgages are also called ARMs. This type of loan has the potential to have monthly payments that change periodically since the interest rate is adjustable. There is usually an initial period of time where the interest rate does not adjust  – such as 1-year, 3-year, 5-year, or 7-years. How often the interest rate adjusts beyond that point will also depend on the loan. Since interest rates do change over time, the payment can either be higher or lower depending on the difference in the interest rate. For example, if someone took out a loan now when interest rates are at record-low levels, it is unlikely that interest rates will continue to be this low when the interest rate adjusts.  Furthermore, adjustable rate mortgages usually have an initially-lower interest rate than a fixed rate mortgage.

It is important to know your future plans when determining the type of loan which is ideal for you. For example, if you are planning on staying in your home for only seven years, it might save you money to use an adjustable rate mortgage with the expectation that you will be moving and taking out a new loan before the interest rate is adjusted. However, what happens if there is a health issue or something else which prohibits you from moving in seven years? What if you cannot move into a fixed-rate mortgage? These things must be taken into consideration when determining whether you can afford your monthly payment – now and later.