Fixed-Rate & Adjustable-Rate Mortgages: What’s the Difference?

The two primary types of mortgages are fixed-rate ones and adjustable-rate ones. There are numerous varieties of the two types, but your first step is to determine which of the types is best for your personal requirements. Here is a look at the differences between fixed-rate and interest-rate mortgages, so you can start deciding which is the most suitable for you.

What are fixed-rate mortgages?

With a fixed-rate mortgage, you are charged a set interest rate that does not change throughout the life of your mortgage loan. The amount of principal and the interest paid can vary from payment to payment, but the total payment remains the same. Therefore, borrowers are protected from potential sudden increases in monthly repayments should interest rates increase, and budgeting becomes much easier for homeowners. Fixed-rate mortgages are also advantageous because they are simple to understand. While fixed-rate mortgages may sound like the best option, the downside is it is difficult to qualify for the mortgage-loan when interest rates are high.

Although the interest rate is fixed, the total amount of interest you will pay depends on your mortgage term. Most commonly, fixed-rate loans are available for terms of fifteen, twenty, and thirty years. If you take out a thirty-year mortgage, you will pay the lowest monthly payment, but you could end up with a higher overall cost. On the other hand, shorter terms are higher because the principal needs to be repaid over a shorter time frame, but they offer lower interest rates.

At the end of the day, it is not the loan amount that will sting you most, but the interest rate. As rate fluctuations occur, your mortgage rate will differ, so it is important to shop around for the lowest mortgage rates.

What are adjustable-rate mortgages?

The interest rate you pay with an adjustable-rate mortgage is variable. The initial interest rate is set below the market rate on a comparable fixed-rate mortgage, and then the rate rises over time. When an adjustable-rate mortgage is held for long enough, the interest rate will surpass the typical rate of a fixed-rate mortgage.

With an adjustable-rate loan, there is a fixed time in which the initial interest rate stays constant. After that initial period, the interest rate will adjust at your pre-arranged frequency. The initial fixed-rate period can vary a lot, from just one month to ten years. Generally, the shorter the adjustment period, the lower the initial interest rates will be. Then, after the initial term, the mortgage resets and a new interest rate is introduced based on the rates of the current market. That rate will remain until the next reset, which could be the following year.

The greatest advantage of an adjustable-rate mortgage is it is considerably less expensive than a fixed-rate mortgage for the initial period, which is usually at least the first three, five, or seven years. Adjustable-rate mortgages are attractive because of their low initial payments, meaning borrowers are more likely to qualify for a larger loan in a falling interest-rate environment.

Which type of mortgage is best for you?

Fixed-rate mortgages are generally ideal for people who are settled in their careers, have a family, and are ready to set down their roots. With a locked-in rate, you will always know how much your repayments will be. On the other hand, adjustable-rate mortgages typically appeal to first-time homebuyers because the lower rates boost purchasing power. With an adjustable-rate mortgage, you get the benefit of a lower introductory rate as well as the flexibility to move away or trade for a larger home before the fixed-rate period comes to an end.