The problem with fixed rate loans is the lender’s problem. Interest rates may increase over the years, but not for your loan. Because of this, lenders will structure your loan to protect themselves.
They will charge a higher rate of interest, and in many instances, higher fees than if you got a loan with an interest rate that would adjust (change) as market rates changed.
A way of reducing the higher rate is by using a buydown. By paying more discount points, you can get a lower interest rate.
Example: You have just sold your home and have $70,000 cash. The new home that you are going to buy only requires a $50,000 down payment. You do not trust yourself not to spend the other $20,000. You now have a choice. You can pay a larger down payment and reduce the amount that you borrow, reducing your monthly payment, or you could choose to buy down the interest rate to reduce your monthly payment.
Your decision will be based on how long you intend to pay on the loan. There are too many different possibilities to cover here. Ask your real estate agent or financial advisor to figure out which is best depending on your specific situation. As discussed, the most important factor is to be realistic as to how long you will keep the property.
There are other considerations besides the interest rate. The cost of the loan (points and fees) will also figure into the mathematical equation as to how many years it will take to make up the additional costs of the fixed rate loan.
The final consideration is the market. Looking at the market conditions for the latter part of 2007, you would have the following factors to consider.
Now, however, the outlook is uncertain.
Oil prices continue to remain high, which creates both the potential for inflation and recession. Although the Federal Reserve Board has reduced interest rates multiple times, inflation could cause it to reverse course and raise them again.
If you believe rates will rise, you want the fixed rate loan. If you think high oil prices will lead to recession and rates will be stable or fall, the adjustable loan will save you money if you are correct.
Some lenders offer a mortgage that can be switched from adjustable to fixed as rates change. Ask your lender if this type of loan is offered.
There is an advantage to a fixed rate loan that does not show by just comparing numbers. A fixed rate loan gives you peace of mind. If rates go up, you are safe. If rates go down, you refinance. Unless you are fairly sure that you will not be in your home five years from now, you are usually better off getting the fixed rate loan.
Here is the problem: You plan to move in five years, so you get an adjustable rate loan. However, rates increase substantially. You now are ready to move up to your next home, which is bigger and more expensive. With the higher prevailing rates, you may no longer qualify or it may be just a bad time to get a new loan. The decision as to whether to get a fixed or adjustable loan gets harder.
There are not just adjustable loans, but combination or hybrid loans that are fixed for a period of years and then adjust as well. There are also adjustable loans that will rise or fall quickly and ones that will react much slower to rate changes. As these loans are discussed later, you will see that there are many factors to take into consideration when deciding between the different loan options.