A mortgage is type of loan that is secured by a transfer of interest in a property to a lender in order to secure the debt amount. If you are unable to make your mortgage payments, the lender is legally able to seize your home as collateral. There are two basic types of mortgage loans: fixed rate mortgages and adjustable rate mortgages.
Fixed rate mortgage loans are available with a steady interest rate that remains the same over the entire term of the mortgage. Every month, for 15 to 30 years, the borrower will make a regular payment to pay back the loan and accrued interest. Some lenders allow borrowers to make payments that are larger than the minimum payment. The purpose of this practice is to save money since the process of paying off your loan faster will reduce the amount of interest that your loan will accrue.
Many fixed rate mortgages allow borrowers to make larger "balloon" payments at the end of the term. This payment option can actually save people money by reducing the amount of accrued interest.
Interest rates for adjustable mortgages tend to vary based on the national and global economic climate. An interest rate for a variable mortgage will continuously compete with other interest rates on the market. As a result, you will have limited control over your ability to plan your payments ahead of time. In a decade or so, your interest rates could be substantially higher.
It is difficult to renegotiate the terms of your mortgage, even when you refinance your home. As a result, you must work with lenders and plan ahead for whether you would benefit more from a fixed or adjustable rate mortgage.
How It Works
Typically, homebuyers do not have funds available to pay the full price for property. For this reason, many people choose to work with a lender. When you borrow money, you need to put a down payment on your mortgage. Depending on where you live and what type of lender you work with, your down payment could be 5 percent or 10 percent of the home price. For many types of loans, you can choose to pay more than the minimum required down payment. The lender will provide the rest of the money for you to buy your house.
Money that you borrow needs to be repaid with interest so that the lender can earn a profit. The entire amount needs to be paid in full within a specific time period, which is usually up to 30 years.
Depending on the terms of your mortgage, you will be required to be interest at a fixed or variable rate. The term "fixed" means that the interest rate remains the same throughout the loan repayment period. The term "adjustable" means that the interest range changes continuously. You can also choose a mortgage that switches from fixed to variable after a specified time period. Once you complete that initial term, you can choose to extend your fixed rate or switch to an adjustable rate mortgage based on your financial situation.
Adjustable rate mortgages vary based on different financial indexes. In general, the government regulates fluctuations. With most adjustable rate mortgages, the interest rate and monthly payment amounts are likely to change every month, quarter, year, three years, or five years.
There are other optional adjustable rate mortgages that allow you to choose your mode of repayment. You can choose to pay a minimum monthly amount, interest only, a normal principal plus interest payment, or an accelerated payment amount. You may need to switch between payment plans, depending on your financial situation.
One advantage of a fixed rate mortgage is that borrowers can predict their repayment amounts ahead of time. If the interest rates are low, it is better to go for a fixed rate loan because your loan will be locked into a lower interest rate. If you are considering an adjustable rate mortgage, you may pay a lower monthly payment if the interest rates are low, but you will need to pay more when interest rates rise. With an adjustable rate mortgage, your ability to predict and control your loan payments is limited.
A financial expert can help you decide whether to select a variable or fixed rate mortgage. If interest rates are at record lows, you will likely want a fixed rate mortgage. If interest rates are high and if you cannot wait to buy a home, you might want to choose a variable rate mortgage.