When you shop for a home loan, you have many choices when it comes to the terms. A few of those choices include adjustable rate and fixed rate loans. There are vast differences between the two and there is no right or wrong answer that works across the board. Your individual factors and future plans help to make the decision the right one for you.
How Long will you Stay in the Home?
The first thing to consider is how long you plan to live in the home you purchase. Is this a short-term purchase or do you see it as your “forever” home? You do not have to stick to these plans tooth and nail, but they can help you make your initial decision when you shop for a mortgage. The general rules usually help:
- The longer you plan on staying in the home, the more sense it makes to take a fixed rate loan. This rate will initially be higher than an adjustable rate, but when you plan on staying in the home for many years, it is more affordable because the rate stays the same year after year.
- If you plan on moving in a few years, typically 5 or less, an adjustable rate can make more sense. The adjustable rate usually gives you a fairly low introductory rate, lower than a fixed rate, but it adjusts after a specified number of years, usually 5 or less depending on the program.
What is your Income Like?
The stability of your income can help you determine if a fixed rate or adjustable rate is a better idea. If you have stable income, a fixed rate will work fine because you can predict the amount of money you will have each month in order to cover your bills. If you have a job where the income varies, such as a commission based position, an adjustable rate might make it easier to afford the loan initially since the rate will be lower. Once you are used to budgeting for your mortgage payment, you can either refinance into a fixed rate loan to avoid the adjustment periods if you stay in the home or keep the loan if you plan to move in the near future.
How Adjustable Rates Work
Adjustable rate loans are very unpredictable after the initial period. There are varying periods, following are a few examples:
- 3/1 – This means that the first 3 years of the loan are fixed at a specific rate and the rate will then adjust once per year
- 5/1 – This works just like the 3/1, with the exception that the fixed period is 5 years
At the first adjustment date, the interest rate will adjust according to the market factors that the loan was based on; this will be specified in your loan documents. After that initial date, the rate will adjust on that anniversary date every year. The rate that it adjusts to will then stay that way for the next 12 months. Some years the rate might increase and others it may decrease. Each loan has a minimum and maximum amount that the loans can adjust to in order to keep it within a specific range, but there is no way to predict where it will be at any given time.
Determining your future plans as well as your work status can help you to determine what type of interest rate is right for you. The most common program is a fixed rate, but there are many borrowers that could benefit from the perks of a lower interest rate for a few years when purchasing a home.