Fixed Rate loans… if you don’t like change
Fixed rate loans are a good idea if you like the notion of paying the same amount every month for (usually) thirty years, and are averse to risk. You will not be surprised by a payment change for the life of the loan and this can be a very attractive feature for many home owners.
Two types of fixed rate loans
The vast majority of fixed rate loans amortize over thirty years, with the bulk of your early payments going toward paying interest. Later in the life of the loan, more of your payment is directed toward the principal. As the interest portion goes down, the principal portion goes up, while the total payment of principal and interest remains the same for the life of the loan. Another type of fixed rate loan is the fifteen year note. They work the same way as the thirty but payments are higher as the term of the loan is much shorter. An advantage of the fifteen year mortgage loan is that it enables you to pay for your house in a shorter time, and you incur less interest costs.
Is there a downside to fixed rate loans?
One drawback of a fixed rate loan is that you have to live with the rate you obtained for the life of the loan. In practice, almost no one stays in the same loan for 30 years. Instead, homeowners refinance on average every five years so for all intents and purposes, most loans are changing all the time. If interest rates fall significantly, it may be worth your while to refinance to a lower rate to save money. As a rule, adjustable rate loans start with a lower rate of interest than fixed rate mortgage loans.
The thought of changing their mortgage can be a huge disincentive to some home owners to make a change even when they could benefit from lower interest rates. So if you are proponent of a low-risk strategy, fixed rate mortgages are just right for you.
When should you change your mortgage?
There are times when it may make sense to abandon the relative comfort of the fixed rate loan you are used to, in order to save money in the long run:
- Your income has gone up substantially and you want to pay off your loan faster. It may be in your interest to refinance to a fifteen or ten year loan, usually at a lower rate, thereby saving yourself substantial interest payments.
- You may have high credit card balances that are eating into your monthly cash flow. Using the equity in your home to pay off high interest credit cards can free up hundreds of dollars every month. You save substantial amounts of money by switching your debt from compound interest credit cards to a simple interest mortgage. Simple is better than compound.
- You wish to take some equity out of your home to invest in a vacation home or investment property.
- You have a second mortgage at a high interest rate and wish to consolidate two payments into one, likely saving yourself some money in the process.
Fixed rate mortgage loans are a stress-free choice for many home owners, but they aren’t the only choice available. Your goal, in the long run, should be to keep as much of your hard-earned money in your pocket as you possibly can.