The foreclosure boom created by the economic downturn has left many homeowners and potential homeowners feeling as though adjustable rate mortgages are evil. However, there has been a great deal of debate on whether or not fixed rate mortgages really save you money. The big fixed rate draw is that you know how much your payments will be throughout the life of the loan, in other words there will be no surprises. Still, having peace of mind and saving money are two different aspects of fixed rate mortgages. If you are considering a fixed rate mortgage there are few things you need to consider when determining whether or not you will be saving money.
The first question to ask yourself is what rate are you looking to lock in, or what is your target rate? The rate you start off at will be the determining factor on whether or not you are able to save money with a fixed mortgage. If you are starting at a rate of 5.3% and your initial monthly payments are more than 60% of your monthly income(s) the odds are you have started off with one foot in the ground. Since, you are not leaving yourself any room to save money. Homeownership is expensive and the first year is often plagued with costly repairs, taxes, and insurance. So, the idea is to get the lowest rate upfront. Although, it is only fair to point out that fixed rates are set usually set higher than those of initial adjustable mortgage rates.
Next, ask yourself what general direction do rates appear to be traveling in? On the other hand, if rates are now at 5.3% and rising then locking in at this rate will definitely save you more than it would if you wait. Yet, if rates seem to be falling then locking in a fixed rate could cost you more in the long run. Since, you will have to refinance in order to take advantage of the cheaper rates. Unfortunately refinancing also comes with additional fees and closing costs. How low will rates ultimately go? There is a “refinancing rule of thumb,” that states that you should only refinance if rates fall at least 2%. So if rates are on a steep decline you could potentially find yourself refinancing at the wrong time. And, you may still wind up with a higher rate than the market rate.
Will there be any other fees or costs that will have a bearing on your payments? Although fixed rate mortgages are not affected by rising interest rates keeping payments constant, there is a chance that you could still end up paying more for your home. The costs of homeowner’s insurances, private mortgage insurance (PMI), and taxes are usually tied to your overall mortgage payment and the costs of insurance and taxes can and usually does rise over the time of the loan. These are aspects of fixed mortgages that are often afterthoughts when homeowners are looking to lock in a fixed rate.
How long do you plan to be in the home? Fixed rates are great long term loans. However, if you are not ready to settle in a particular area for at least 10 to 15 years, then fixed rates mortgages may do more harm than good. Homeowners with fixed rates, who decide to sell their home often, find themselves selling the home for less than what is owed on the loan when the market is down. If you are not planning to be in the home for at least 10 years odds are good you will end up loosing money in the long run.
Finally, are you really going to budget wisely? Again, the major advantage to fixed rate mortgages is the peace of mind in knowing that interest rates will not cause your monthly payments to increase. Theoretically, this feature gives homeowners the opportunity to budget wisely. However, most people don’t follow a budget until they have no other choice. And it should be noted that budgeting doesn’t necessarily lead to saving money. Knowing how much your payment will be each month will not change your income and what you are able to put aside for a rainy day. It simply shows you where the majority of your money is going.
Adjustable rate mortgages have been painted as the enemy, but in reality these mortgage rates offer a flexibility that fixed rates do not allow. There is no doubt that fixed rate mortgages offer a peace of mind that adjustable rate mortgages just cannot provide. Still, having a budget and saving money is totally different. So, you may want to really weigh all options before deciding on a fixed rate, especially if you are attempting to save money.
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Allan Young is a freelance writer who writes about mortgage rates.
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