Mortgage Rates: Fixed or Adjustable Rate?

While mortgage rates are historically low, you'll want to find the best way to make home loan interest rates work for you. Fixed mortgage interest rates offer a stable principal and interest (P & I) payment throughout the life of the loan. Adjustable rate mortgages typically offer a lower-than-market rate initial interest rate that converts to an adjustable rate after a specified period. Adjustable rate mortgages reset at a specific intervals shown in mortgage documents. You may see ads for 1/1, 3/1, 5/1 and 7/1 adjustable rate mortgages. The first number represents how long the introductory rate will last; the second number indicates how often the mortgage rate will adjust. A 3/1 adjustable rate mortgage offers an introductory rate for three years and its interest rate would adjust yearly after the introductory rate expires.

Why Consider an Adjustable Rate Mortgage

If you plan to sell the home you're buying in a few years, you may prefer the benefit of the low initial rate offered by an adjustable rate mortgage. Adjustable rate mortgages provide lower monthly payments and you can eliminate the fluctuation of your mortgage rate and house payments if you sell your home before your initial interest rate expires. Here are a few things to consider when shopping for an adjustable rate mortgage.

Prepayment penalty or premium: This is a penalty assessed by the mortgage lender if the adjustable rate mortgage is paid off before a specific date. Always ask mortgage loan officers if there is a prepayment premium on any adjustable rate mortgage you're considering.

Index used for calculating adjustable rate mortgage payments: Mortgage lenders use financial indexes to determine how adjustable mortgage rates change. It's important to know which index a lender is using for its adjustable rate mortgages. Researching how the appropriate index performs can help you understand how your mortgage rate may increase.

Adjustable rate caps: Adjustable rate mortgages typically contain caps on how much a mortgage rate can increase at each adjustment period, and a lifetime cap on how much a mortgage rate can increase over the life of a loan. According to the Consumer Financial Protection Bureau, caps are intended to protect mortgage borrowers, but lenders may also incorporate limits on how much an adjustable mortgage rate can decrease.

Negative amortization: This is an exotic feature used by mortgage lenders to keep monthly payments low by charging a below-market introductory rate and adding the difference between the initial rate and market rate mortgage rates to the loan balance. This means that your payments may be affordable, but that your loan amount will increase rather than decrease. Always verify that adjustable rate mortgages you're considering don't include negative amortization.

Fixed Mortgage Rates: No Surprises

The fixed rate mortgage is a reliable way to finance a home purchase or refinance an existing mortgage. Your P & I payments won't change, which makes household budgeting easier. While a 30 year fixed-rate mortgage is considered standard, you may want to consider a shorter repayment term. You can potentially save thousands of dollars in interest paid over the loan term and mortgage rates for shorter repayment terms are lower than for 30-year mortgages. The trade off is higher monthly mortgage payments. If this is a concern, look for a 30-year fixed rate mortgage without a prepayment premium. This scenario allows you to prepay your mortgage when you want without the commitment of a higher monthly payment.

The Federal Trade Commission recommends shopping multiple mortgage quotes. When you're ready to look for a mortgage, our network of mortgage lenders can help.

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