Determining your wants and needs is the first step to identifying the right loan for you. Is it important to you to have your payments remain the same every month, or are you more concerned with having a lower initial interest rate? There are pros and cons to each of these types of loans.
Fixed Rate
With a fixed rate loan, your principle and interest portion of your monthly payment stays the same every month, despite fluctuations in the market. This allows you to easily calculate your monthly expenses without worrying about fluctuating loan payments. It is important to note that taxes and insurance rates do fluctuate
In order to get a lender to commit to lending you money over the full term of the mortgage, you will usually pay a higher interest rate on a fixed rate mortgage. If interest rates fall significantly after you have obtained this loan, you will be unable to take advantage of them, unless you refinance.
Variable
A variable mortgage, sometimes called an adjustable rate mortgage (ARM) can be procured with a lower initial interest rate than a fixed rate mortgage. This type of loan can be attractive to homebuyers that plan to move in a few years and are not concerned about possible interest rate increases. People who are confident that their income will increase faster than potential increases in the market rate also like to take advantage of this type of loan. Many people who are relocated to another area by their employers know they will only be in a certain location for a limited amount of time. This scenario makes a variable loan extremely attractive, due to the lower initial interest rate.
This type of loan’s interest rate is adjusted periodically to keep in line with changing market rates. If interest rates increase, so do monthly payments. Conversely, payments drop when interest rates decrease.
Before deciding on this type of loan, it is important to know how much mortgage payments can increase. For this reason, ARMs are designed with two caps, or limits to the amounts which payments can increase.
The first cap limits the amount an interest rate can increase during each adjustment period. For example, if an ARM adjusts annually may have a 2% cap. The adjusted interest rate can never be more than 2% higher than the year before.
The second cap limits the total amount of interest adjustments during the life of a loan. If an ARM has a 6% lifetime cap, a borrower may be confident in knowing they will never be required to pay more than 6% above the original rate. For example, an ARM with an initial rate of 5% and a 6% lifetime cap will never be more than 11%.
Remember to contact your real estate professional for information prior to deciding on the best loan for you.