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Choosing between a fixed rate or adjustable rate loans is the single
most important nail-biter of a decision you'll ever make when choosing
a mortgage. The mortgage formula -- the method used to determine
how much you pay based on your interest rate -- is the same for
both types of mortgages. What differs is the very good chance
that your monthly payment amount will change through the life of
the loan.
How willing and able are you to take on financial risk?
Consider an adjustable-rate mortgage only if you're financially
secure enough to handle the maximum possible payments over an extended
period. You must also be emotionally secure enough to handle volatile
rates. Don't take an ARM because the initially lower interest rates
allow you to afford the property you want to buy (unless you're
absolutely certain that your income will rise to meet future payment
increases). Try setting your sights on a property that you can afford
– with a fixed rate mortgage.
How long do you plan to keep the mortgage?
A mortgage lender
takes extra risk in committing to a constant interest rate for 15
to 30 years. Lenders don't know any better than you or I what may
happen in the intervening years, so they charge you a premium for
their risk. If you aren't going to keep your mortgage more than
five to seven years, you're probably paying unnecessary interest
costs to carry a fixed-rate mortgage.
Savings on most adjustable rates are usually guaranteed in the first
two or three years. An adjustable-rate mortgage starts at a lower
interest rate than a fixed one. When the adjustable does what it
does best – adjusts – it's almost always limited or capped in the
amount of each interest-rate change. If rates rise, you can end
up giving back or losing the savings you achieve in the early years
of the mortgage.
If you are pretty sure that you'll hang onto a property for less
than five years, you should come out ahead with an adjustable.
Which way are interest rates going?
Some people ask, "shouldn't the likelihood of interest rates going
up or down determine whether I take a fixed-rate or adjustable-rate
mortgage?" (The logic goes that if rates are on their way up, then
you're better off locking in a fixed-rate mortgage before it goes
any higher.)
Forget it. You can't predict the future course of interest rates.
If you could, you could make a fortune investing in bonds and interest-rate
futures and options. Even the pros on Wall Street can't make these
predictions with any consistent accuracy.
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