Typically, you don't pay cash when purchasing a home. Instead, you get a lender to pay the seller on your behalf. From there, payments are made each month for 10, 20 or 30 years to the lender until the home is paid in full. Home loans can come with either a fixed or adjustable interest rate. The type of loan that you choose depends partially on how long you intend to own the home and partially on your current financial situation. Generally speaking, it is possible to refinance an adjustable rate loan into one with a fixed rate if it no longer meets your needs. This can be especially beneficial if you think that interest rates on home loans are going to increase in the near future.
Difference Between Fixed and Adjustable Rate Mortgages
If your home loan has a fixed rate, it means that the rate won't change for the life of the mortgage. This is true whether the prime rate goes up or down during the repayment period. If you have an adjustable rate mortgage, the rate is set for a period of several years before it changes based on the prime rate.
Since the interest rate on a fixed rate loan doesn't change, it means that you make the same payment for as long as you hold the loan. With an adjustable rate loan, your payment could increase, which means that you will pay more for the home overall. It could also require you to extend the term of the loan to keep your payment to an affordable level.
Benefits of Fixed Rate Mortgages
Perhaps the biggest benefit of a fixed-rate loan is that your payment won't change for however long it takes to pay off the loan. If your mortgage payment is $1,000 per month today, it will be $1,000 a month 20 years from now. Thanks to inflation, that $1,000 payment will likely represent a smaller portion of your income 20 years from now than it does today.
As your payment remains the same for months and years into the future, it makes it easier to create your household budget. If interest rates go up, you won't have to worry about how it will impact your ability to remain in your home. Loans offered by the FHA and USDA come with fixed rates, which means that most buyers are eligible for them.
Benefits of Adjustable Rate Mortgages
The primary benefit of an adjustable rate home loan is that the initial interest rate is often lower than that of a fixed-rate mortgage. This means that your mortgage payment may be hundreds of dollars lower per month, which makes it easier to qualify for a loan. In most cases, the interest rate on such a loan remains the same for up to five years.
Therefore, if you plan on living in your home for less than five years, you can get a lower interest rate without having to worry about it changing in the future. If interest rates go down, your mortgage payment will go down as well. Therefore, this can be an ideal option in poor economic times or in times of low inflation.