2. Fixed-Rate Mortgages
A fixed mortgage rate has a fixed interest rate for the entire length of the loan, which is typically 15 or 30 years. With a fixed-rate mortgage, the interest rate on the loan remains the same and the amount of the monthly mortgage payment does not change. One advantage of this is that you will always know what your monthly payment will be, making it easier to budget your finances for the long-term. However, some important drawbacks to consider when deciding on a fixed-rate mortgage are:
30 year versus 15 year fixed rate mortgage:
Once you decide you want a fixed-rate mortgage, the next decision is whether you will want a 30 year or a 15 year loan:
Example
Lets take a $150,000 mortgage and compare how much you would pay on a 30 year fixed-rate mortgage with an interest rate of 6.84 percent versus one for 15 years at 6.10 percent. On the 30 year loan, your monthly payment will be $961 versus $1,274 for the 15 year loan. However, you will pay a total of $196,304 in interest for the 30 year loan, versus only $79,304 for the 15 year loan - a savings of $117,001!
A fixed mortgage rate has a fixed interest rate for the entire length of the loan, which is typically 15 or 30 years. With a fixed-rate mortgage, the interest rate on the loan remains the same and the amount of the monthly mortgage payment does not change. One advantage of this is that you will always know what your monthly payment will be, making it easier to budget your finances for the long-term. However, some important drawbacks to consider when deciding on a fixed-rate mortgage are:
- The interest rate is often higher than that of a adjustable-rate mortgage.
- Fixed-rate mortgages are not assumable, which means you cannot transfer your existing mortgage to a new buyer if you sell your home.
- Some fixed-rate mortgages have prepayment penalties.
30 year versus 15 year fixed rate mortgage:
Once you decide you want a fixed-rate mortgage, the next decision is whether you will want a 30 year or a 15 year loan:
- The main advantage of a 30 year mortgage is that the monthly payments will be lower because you have a longer period to repay it. This translates into more payments, and considerably more money paid in interest than with a shorter-term mortgage loan. However, lower monthly payments can free up more of your monthly income which can potentially be put to more productive uses, such as a retirement fund or other investment securities. Another advantage in taking a 30 year mortgage is that the interest is tax deductible, which will reduce after-tax cost. In addition, you retain the option of paying off your mortgage faster in the future if you so desire so long as you do not have a prepayment penalty.
- With a 15 year mortgage, the main advantage is the large sum of money you will be saving on interest when compared to a 30 year mortgage. In general, the shorter the term of the loan, the lower the interest rate will be, therefore you may also be able to get a lower interest rate, which can vary between one-quarter and one-half percent lower than a 30 year mortgage. However, because the loan is for a shorter term, the monthly payments will be larger, and the tax deduction will be smaller because a smaller portion of your monthly payment is going towards interest. You also risk defaulting on your mortgage payments if you find yourself experiencing financial hardships.
Example
Lets take a $150,000 mortgage and compare how much you would pay on a 30 year fixed-rate mortgage with an interest rate of 6.84 percent versus one for 15 years at 6.10 percent. On the 30 year loan, your monthly payment will be $961 versus $1,274 for the 15 year loan. However, you will pay a total of $196,304 in interest for the 30 year loan, versus only $79,304 for the 15 year loan - a savings of $117,001!
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