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Fixed Rate Mortgages Are Not Always The Best Option
When it comes to choose between fixed rate mortgages and those of adjustable rates, there are quite a few circumstances that needs to be taken into account so that you do not fall into any false situation where you end up paying more.
While a fixed interest rate have certain advantages especially when it come to long term dealings, at times this type of loan structure could become disadvantageous.
Let us understand when.
You pay the same even when rate of interests drop
Of all the circumstances that will make you bite your nails for choosing fixed rate loans, nothing is more disappointing than witessing rate of interest take a dip in the southward direction.
As you have signed up to repay a fixed monthly amount over the very long term, you will end up paying similar interest whereas people who had opted for floating interest will enjoy the benefits of a decreasing rate of interest.
This essentially mean that when markets are going down, you will be paying above the market.
The irony of this can be suffocating to some people.
You end up paying more
When you go for a long term mortgage plan, the overall amount that you have to pay in the form of interest is much more than you would have paid if the term was short.
Fixed mortgage plans are designed in a way that will make you pay higher amounts of interest over a long period. It doesn’t matter how much negotiation you put in.
The monthly repayment makes up a portion of interest and a portion of principle.
The total sum you pay is calculated based on the full tenor of the initial loan structure.
No benefit on foreclosure
The amount you pay back every month is actually a combination of the principal amount and the interest amount.
The calculations are done in way that during the initial phase majority of the amount that you pay back monthly is interest and a lesser portion comprises of the principal.
Hence during initial years you pay more of interest and less of principal back to the mortgager.
In case you want to foreclose the mortgage you will have the following disadvantages:
- While foreclosing, you pay back the principal amount and a small penalty on the principal amount (although many companies are waiving the foreclosure fees nowadays).
- You need not pay the outstanding interest amount in case of foreclosure.
- As during a long term loan you pay less principal in the initial years and more interest, hence while foreclosing the overall outstanding principal amount would be very high hence all in all you would be ending up paying a lot more amount which certainly is a huge disadvantage.
Overall rate if interests are higher
The rate of interest that you are required to pay for a short term package is much lower as compared to a long term one. The high rate of interest will make you pay an extraordinary excess amount.
This however is being neglected by many borrowers as what matters to them is the monthly payment that they need to make and as long as that amount is low, not many people are bothered what is the overall amount that is getting drained out of their pockets.
If you are convinced that you are being played by the lender, consider loan modification options as they can make a huge difference to you financial well-being.
When To Choose Fixed Rates Or ARM
The decision that you will put the most focus on when deciding which mortgage to take up is whether to go for fixed rates or an ARM.
There are pros and cons for both types of loans. But if you have decided to go with one them, it will most likely be one of these reasons, if not all of them.
When you want a fixed rate?
When mortgage rates are lingering at a low level compared with where it has been in the last 2 years.
If interest rates are high, why would you want to lock in to one?
So when the market is low, lock in your rates for the long term.
When you are sure you are going to live in this house for the long term.
There are many reasons why home buyers choose to go with adjustable rates. One of the most common is that they know they will be moving in the near future and has to sell the house.
So even though fixed rates can look very attractive at times, these buyers cannot sign up for them as these loans will have a lock in period which charges them a penalty fee should they redeem the loan with sale proceeds too soon.
You wouldn’t have this headache if you intend to live in a home till you retire.
You have a risk-adverse personality and prefer the stability of knowing how much you will pay with fixed interest rates.
Some people have no problem paying premium rates as they view paying extra comes with peace of mind over time.
That is worth the extra that they are willing to pay.
When you want an ARM?
When mortgage rates are exceptionally high compared to the last couple of years.
Because there is a good likelihood that rates will decrease in the near future, going with adjustable rates mean that a home owner will reap the benefits of falling interest rates.
At the same time, if rates are exceptionally low, ARMs will not look so attractive over the long term.
When you are one of those people with a job that requires you to travel over long periods.
It is a global marketplace now.
People from all over the world is relocating to every corner of the globe due to job commitments.
It is not surprising anymore to see someone who spends more time overseas than at home.
Under these circumstances, ARMs allow you to enjoy lower interest rates.
By the time market conditions go up, you could have already moved on to another city or country.
If you have made your own judgement that mortgage rates will remain low or fall even lower, you can take advantage of that with adjustable rates.
As these types of loans are usually pegged to an index, your interest falls should these indexes fall.
A common index that is used to peg home loans is the LIBOR.
There are many variations to it as well. It can vary between time frames like a 1-month and 1-year, and also vary between currencies like USD and GBP.
When you have to go for mortgages, it is usually recommended that if your financial budget allows, you should opt for short term plans and not long term plans.
While working out your budget and financial forecasting, remember to involve your spouse and other family members so that you will not miss out on important commitments that will affect your budget.