Buying a home is a significant accomplishment. As you’re separating your wants from your needs and finding your perfect home, spend some time understanding your mortgage loan options.
Lenders like Needham Bank offer two basic types of mortgages: fixed-rate mortgages and adjustable-rate mortgages. While you will likely find different loan options within those two categories, your first decision is to choose whether you want a mortgage with an interest rate that never changes during the period of the loan, or one that starts low but varies over the loan period (either increasing or decreasing).
Predictability with fixed-rate mortgages
When it comes to budgeting, you know what you’ll get with a fixed-rate mortgage.
- Fixed interest rate: Fixed-rate mortgages offer interest rates that will never change over the term of your mortgage. If you’re borrowing during times of low interest rates, this is a valuable perk because you’ll pay less money in interest.
- Predictable payments: With a fixed-rate mortgage, your monthly total principal and interest will not change. However, you’ll see an increase in your monthly payment if your municipality raises taxes every year, as most do, and you’re paying taxes through your mortgage payment and not separately. Due to amortization, the process of spreading payments over multiple periods, more of your payment will go toward interest in the first years of your mortgage. In the latter stages of your mortgage term, more of your monthly payment will go toward principal.
- No surprises: Because your rate is fixed, it’s easier to figure out your monthly allocation for housing. But if you’re borrowing during a time of high interest rates, this mortgage’s payments might be less affordable than other options.
- Term: Another factor to consider with a fixed-rate mortgage is the term of the loan. Thirty years is the most popular option because it offers the lowest monthly payment. With a 30-year term, however, you’ll pay more for your home over the life of the mortgage than you would with a 15- or 20-year term, since you’re paying 10 or 15 additional years of interest.
Fixed-rate mortgages are best if…
- You want to know what you’re going to pay for your mortgage every month.
- You plan to live in the home for 10 years or more.
- You’re borrowing during a period of low interest rates and the first two points apply to you.
Flexibility with adjustable-rate mortgages
An adjustable-rate mortgage (ARM) offers attractive features for some borrowers.
- Fluctuating rate: Adjustable-rate mortgages offer fixed rates for specific periods—usually one, three or five years. The interest rate for these mortgages will then adjust frequently over the life of the loan, depending on how the mortgage is structured. In the early stages of the ARM, your interest rate will be lower than the lowest rates offered on fixed mortgages. Depending on market conditions, your ARM can increase sharply or gradually, or it could decrease. It’s uncertain, which is why it’s important for you to determine whether you can afford larger monthly payments if your mortgage adjusts upward.
- Larger loan: Along with lower initial payments, you can also qualify for a larger loan because you’re not paying as much in interest at the start. If interest rates continue to decrease, you’ll enjoy lower mortgage payments and lower rates without refinancing your mortgage.
- Interest rate ceiling: There is a ceiling that caps your ARM’s rate increases, which varies by lender. Your interest rate will adjust based on activity of a particular index, such as interest rates on certificates of deposit or Treasury bills. Keep in mind that interest rates on ARMs can double within a few years.
Adjustable-rate mortgages work if…
- You want an initial rate that starts below current market rates for fixed mortgages.
- You plan to live in your house for approximately five years or fewer (or before the fixed-rate period ends).
- Interest rates are relatively low now, and you believe they could go lower in the future.
Buying a home is an exciting life stage. Make sure the type of mortgage you select will work for you both now and in the future.
Want to learn more? Use our mortgage calculator to compare your payments with both mortgage types. Make sure you choose the proper mortgage to suit your needs. Contact our Residential Lending team to learn more and let us help you find the right mortgage rates and options for you.
