Tuesday, February 17, 2009

How a Fixed Rate Mortgage can be Beneficial When Buying a Home

If you are just about to buy a house, one of your most important decisions, almost as important as which home you buy, is what type of mortgage to take out. You basically have two choices; a fixed rate mortgage (FRM) or an adjustable rate mortgage (ARM) Choosing a mortgage that best fits your specific needs can potentially either save or cost you a great deal of money over the term of the mortgage.

Around 70% of homebuyers today choose a fixed rate mortgage, rather than an adjustable rate mortgage. A fixed rate mortgage is exactly what it sounds like. The interest rate on the loan doesn’t change, regardless of whether interest rates in general go up or down. An adjustable rate mortgage may go up or down, depending on the interest rate at the time. Your decision may be influenced by your overall financial situation, the present state of the economy and the cost of your house.

The overall amount that you end up paying for your home can be greatly influenced by even a small change in the interest rate. A lowering of the interest rate by just one point can mean that a homeowner with a 30 year mortgage can enjoy average savings of around $50,000 over the term of their mortgage. An increase in the interest rate of just one or two percent can mean monthly payments that are between $50 and $250 higher, depending on how much you paid for your home. Whether you are taking out a 15 or 30 year mortgage may also influence your decision to take out an adjustable rate or fixed rate mortgage.

The biggest benefit of a fixed rate mortgage is the peace of mind that comes with knowing that regardless of how bad the economy is the rate on your mortgage loan won’t increase; neither will your monthly payment amounts. In fact, the terms and conditions of a fixed rate mortgage are protected by law. A fixed rate mortgage is an ideal option for those buyers who just don’t want to take a risk, or consider themselves the cautious type when it comes to finances.

Another benefit of a fixed rate mortgage is that it makes it easier for the homeowner to budget the expense. Your mortgage payment is probably your single biggest expense and you always know exactly how much the monthly payment will be. Some buyers believe that this makes it a little bit easier to plan and budget for some of life’s other big expenses. Certain things like college funds and retirement for example. With a fixed rate mortgage, the amount of the monthly payment will only increase if there is an increase in the amount of insurance rates or property taxes.

A fixed rate mortgage is not affected by inflation or the cost of living. Supposing you have a monthly mortgage payment of $700; this amount will still be the same after five, ten, and twenty years have gone by. Even though everything else has increased in cost, your mortgage payment will stay the same. One way to offset this is to consider the possibilities in the future. Chances are you could have a more disposable income as time passes. You could be earning a higher salary, but still paying the same every month for your home.

If you prefer the safer option of the fixed rate mortgage, one solution would be to take out a fixed rate mortgage and then refinance your loan if and when interest rates are lowered. This approach keeps your options open. If interest rates go down sufficiently to justify the cost of refinancing, you can do just that; if rates stay where they are or go up you will be glad you have the fixed rate mortgage. Some financial experts advise that it is only worth refinancing if the interest rate will be at least 2% lower than your current rate, although that decision entirely is up to you.

Another strategy that can be applied towards either a fixed rate or adjustable mortgage is to pay an extra amount each month towards the principal. By doing this regularly, you can potentially save a large amount in interest charges. It can also make the term of the mortgage shorter and you may be able to own your home sooner. Make sure that you specify that any extra amount that you pay is going towards the principal and not the interest. By doing this, if you have a fixed rate mortgage and the rate is not as low as it could be, you are getting ahead a little bit.

Ultimately the decision of whether to take a fixed rate mortgage or an adjustable rate mortgage is yours. Although several factors may influence your decision, one of the biggest questions to ask yourself is how much of a risk you want to take.

About the Author

Shawn Thomas is a freelance writer who writes about economic issues and financial products pertaining to the mortgage industry such a fixed rate mortgage as well as the lowest mortgage rates.

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