When buying a home, most of us need to take out a mortgage. This long-term loan might very well be the largest sum you ever borrow, so it’s important to take out the best loan for your circumstances.
Mortgages come in all shapes and sizes, being typically determined by a number of factors, including the size of your down payment and your credit history. You’ll have a choice of a fixed rate, variable rate or adjustable rate mortgage. This first part of our series of handy mortgage guides aims to clear up some confusion and explain exactly what a fixed rate mortgage is.
When you take out a mortgage, you’ll be required to make regular repayments, normally monthly. Even if you do decide you want to pay your mortgage faster, make sure you know what this entails. Lenders take a big risk when they cough up the cash required to buy a home, so it’s only natural that they expect to gain something from the transaction. They charge interest on the loan to ensure they get back the full amount they’ve lent you, plus some extra.
Typical loan terms last between 6 months and 10 years and will generally need to be renewed several times during the total amortization period—the time it takes to pay off your entire mortgage, a maximum of 25 years. A fixed rate mortgage locks in the amount of interest you’re required to pay for the full duration of your term. So, if you take out a 10-year loan, with an interest rate of 4%, you’ll pay 4% interest on each and every payment.
The Benefits of a Fixed Rate Mortgage
There are clear benefits to taking out a fixed rate mortgage, especially if you’re on a tight budget. The biggest attraction is that you will know the exact amount you will be required to pay each month. This makes setting a budget and sticking to it much easier.
In addition to this, you don’t have to worry about your repayments increasing over time due to rising market interest rates. Indeed, even a 1% rise can increase your monthly payments by upwards of $100 overnight, something you might not be ready for.
The Disadvantages of a Fixed Rate Mortgage
In order to cover themselves against rising interest rates, lenders will typically set rates on their fixed rate mortgages that are higher than the market’s. As a result, one of the biggest drawbacks with a fixed rate mortgage is that you can often end up paying more in interest than you would with other types. On a fixed rate mortgage, rates may fall dramatically, but you’ll be locked in and paying the higher rate for the duration of your term.
When to Take Out a Fixed Rate Mortgage
Taking out a fixed rate mortgage can be as much about understanding the market and your own budget as it is about your lifestyle and personality. If you’re likely to lose sleep over the fact that your monthly repayments could rise all of a sudden, a fixed rate mortgage might be the best option for your peace of mind.
The optimum time to take out a fixed rate mortgage is when market interest rates are at a low. At this point, rates can only go so much lower and are more likely to rise in the future than drop further. As such, your fixed rate mortgage should sit somewhere in the middle and won’t suffer too much from market swings.
Fixed rate mortgages have their pros and cons but have long been the most popular choice for homeowners. This is perhaps because the stability offered outweighs any potential savings you might make.