Purchasing a new home can be a very exciting time. It can also be very complicated, especially when it comes to figuring out how you’ll pay for this purchase. You’ll probably be looking into financing, which means taking out a mortgage. Which means paying interest on your home loan. Your interest payment could come down to the type of mortgage loan you take out, so you need to choose between a fixed vs. adjustable-rate mortgage.
But what is fixed rate mortgage? Unlike an adjustable rate mortgage or a variable rate loan, it is a mortgage with a set interest rate, often translating into a monthly payment, that will not change over the life of the fixed rate loan. Pretty straightforward. But while it can be easy to understand, there are still factors you should consider before deciding on whether to opt for a fixed-rate mortgage or an adjustable-rate mortgage. We also suggest consulting a real estate agent before diving into the world of mortgage costs. It is important to understand the difference between a listing agent vs a selling agent before taking the next steps.
Fixed-rate mortgages are overwhelmingly the choice most new homeowners opt for currently. In fact, near the end of September 2021, adjustable-rate mortgages only made up 4.1% of all mortgages being taken out, and that figure was up from 2.3% at the start of 2021. Those figures show that just about everyone is opting for fixed-rate mortgages.
The easy answer is that there’s never been a better period to get fixed-rate mortgages. In February of 2022, average rates on a 30-year fixed-rate mortgage were at 3.89%. On a 15-year fixed-rate mortgage, they were at 3.14%. And that’s up 2.97% and 2.34% the previous year. These are historically low and are one reason fixed-rate mortgages are so popular. But there are signs that things might be changing.
Back in the early 1980s, average rates for fixed-rate mortgages were around 18%. That shows just how low the current rates are comparatively. But why do rates fluctuate so much? Numerous factors play into average rates, some of which are in your control and others that are determined by the current market conditions.
Some factors that determine the rate you will pay are things you have no control over. This is one reason why we can see the fixed interest rate averages fluctuate so much over the years: outside factors have a major impact on the average rates. These factors include:
The Fed is also a large purchaser of mortgage-backed securities, a technique they use to keep rates low and stimulate the economy. If they scale back this buying, demand for this investment will wane, and rates will go up.
Of course, the Fed isn’t taking out a mortgage for you. So while the larger market activity can have a major effect on your mortgage rate, there are still things within your control that can significantly lower your rate and your monthly mortgage payment. These include:
You may also notice that your loan has an APR. This is not the same as your interest rate, though it is similar. Your APR calculates all the expenses associated with your loans (e.g. origination fees, insurance costs, points, etc.) whereas your interest rate is simply the interest on the money borrowed. Because of this, your APR may be slightly higher than your interest rate.
Since fixed-rate mortgages are loans where the interest stays the same over the life of the loan, it follows that adjustable-rate mortgages are loans where the rate changes over the life of the loan. However, this doesn’t simply mean your rates will change daily, making it impossible to plan your payments. Instead, adjustable-rate mortgages have two periods.
At the start of your adjustable-rate mortgage, it will work exactly like a fixed-rate mortgage. There will be a set amount of time (likely somewhere between three and ten years) that you will work out with your bank where your rate will not change. Only after the fixed period will your adjustable-rate mortgage start fluctuating.
After your fixed period, your adjustable-rate mortgage will start to change every year or six months based on what you’ve worked out with your lender. Your rates will then change within a set of rules you’ve worked out. These rules include:
Before deciding on what type of mortgage you should be looking at, it’s important to calculate what you can afford in terms of a new home. Once you’ve done that, you should consider these factors when choosing a loan:
At Berkshire Hathaway HomeServices California Properties, we recognize that buying a house is a complicated process. Sometimes it helps to simply be able to talk things over with an experienced agent who can guide you through the ins and outs of your financing options.
Our financing services can connect you to a mortgage consultant who will be able to go over your options with you. You can also use our mortgage calculator to determine how much you will be paying over time. If you’re also wondering what the difference is between under contract vs pending contract or what closing costs are, check out our mortgage glossary and blog for the clarification you need. We provide the tools so you can feel confident buying your new home.