Are you planning on buying a home? When you do, you will have to examine the types of loans available to you. What do fixed rate mortgages offer you?
Fixed rate mortgage definition
A fixed rate mortgage is a loan that has an interest rate that is fixed over the period of the loan. Your interest rate will neither increase or decrease as interest rates change over the years. Therefore, your payments will remain the same throughout the course of the loan.
Advantages and disadvantages
The advantage of having a fixed rate mortgage is that you will know exactly what you must pay every month, without guesswork, until you have repaid the loan. This can make planning for your future much easier, and you will not have to worry about being affected if interest rates increase.
The main disadvantage of having a fixed rate mortgage is that you cannot take advantage of lower interest rates without refinancing. Depending on your mortgage's interest rate, refinancing charges and the period of time that you plan on staying in your home, it might make economic sense to refinance to another type of loan. Otherwise, you'll have to live with the higher interest rate.
In addition, you may pay a little more overall for a fixed rate loan because lenders calculate their uncertainty about how interest rates will change over the years into a fixed rate loan.
Types of fixed rate mortgages
Traditionally, most people took fixed rate loans out over a 30-year period. Today, the 30-year option continues to be popular, but consumers have more options. Many people opt for a 15-year fixed rate loan. Some mortgage companies offer 20-, 25- and 40-year options.
How do you choose the right time period for your fixed rate mortgage? You start by balancing the amount of money that you can afford to pay on a monthly basis with the amount of interest that you will pay over time. For example, if you have a 30-year fixed rate mortgage, you might be making lower payments than if you were to have a 15- year fixed rate mortgage; however, you will be paying more interest and therefore will have a larger overall loan payback.
Remember to consider your taxes, too. You will probably be able to deduct interest for a longer period of time when you pick a long-term loan versus a shorter-term loan.
Another type of fixed rate mortgage is the biweekly payment mortgage. With this mortgage, you get a standard 30-year mortgage but pay every two weeks instead of every month. This lowers the amount of interest that you pay over time and can result in a faster payoff.
If it is not advantageous to refinance your 30-year loan to a biweekly payment mortgage, find out if you can add to your payments monthly, or even more frequently, for overall savings. If you add one extra monthly payment per year, either in a lump sum or over the course of the year, you can pay off your loan much more quickly, saving interest in the process. These additional payments should be specifically directed to the principal of the loan; your regular payments typically pay off interest first or a percentage of interest and principal.
Watch out for fixed rate mortgages that come with prepayment penalties. You should be able to pay down the loan on your schedule, not your lender's.
Fixed rate mortgage variations
There are a number of loans available that combine the features of fixed rate loans and variable rate loans. Graduated payment loans offer low fixed monthly payments for a given period of time at the beginning of the loan. Payments then increase over a period of time based on set rates. Finally, the loan payments become fixed at a higher level than that which was paid at the beginning of the loan for the remainder of the mortgage's term. These mortgages help you build equity at an accelerated rate, but you'll need to be sure that your income increases in line with the rising payments.
Balloon mortgages offer advantages to a few, but should not be taken lightly. A balloon mortgage offers fixed payments for a given period of time, after which the entire balance of the loan is due. Most homeowners are able to refinance the mortgage before the balloon payment, but there are no guarantees that you'll be able to do this, or that interest rates will be lower when you refinance.
What's best for you?
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