In terms of interest rates, mortgages can be categorized into two kinds – variable rate mortgages and fixed rate mortgages. Variable rate mortgages (also known as adjustable or floating rate mortgages) are those with an interest rate that changes according to market conditions and the lender’s discretion. With fixed rate mortgages, the interest rate stays constant throughout the tenure of the loan, irrespective of any ups and downs in the economy.
As the interest rates are close to their all time lows currently, this is a great time to go for a fixed rate mortgage. If you are a first time buyer, you should acquaint yourself with the way fixed rate mortgages work. You also need to know what are the advantages and disadvantages of choosing this type of a mortgage.
When you have a fixed interest rate, your monthly payments will not be subject to any variation. This can affect you in two ways. First of all, even if the lending rates go up drastically, it will have no effect on the terms of your mortgage agreement. Since you have an idea of what your future payments are going to be, you can budget and plan your finances with certainty.
The second advantage is that you will remain shielded from interest rate risk. This means that even if the rates go up significantly while your income stays at the same level, you would not have to face the threat of foreclosure.
The downside is that when the interest rates go down, you will lose out on the possibility of reduced monthly payments. Long term fixed rate mortgages also tend to carry slightly higher interest rates as lending institutions try to cover the risks involved to ensure an adequate profit margin in the event that market rates increase.
The duration for a fixed rate mortgage is typically 15 to 30 years. Nowadays, loans are sanctioned for shorter (5 to 10 year mortgages) and longer (40 to 50 year mortgages) tenures as well. The longer terms normally apply for expensive homes. People usually choose a 15 year or 30 year mortgage as they have become industry standard.
Even if you go for an adjustable rate mortgage initially, you can later refinance and opt for a fixed rate for the outstanding balance. You should do this if you want to move to a constant rate of interest because your financial situation has changed or if you want to lock-in a low interest rate.