By Carey Pott
Apples vs. oranges. Boxers vs. briefs. Dave Letterman vs. Jay Leno. These debates may rage on for decades, and we can add another one to the list: fixed vs. adjustable. We�re speaking, of course, of fixed rate and adjustable rate mortgages.
Let�s start the discussion by talking about risk. If I had to pick one word that explained the mortgage industry, it would be risk. If you can understand the concept of risk and how it relates to mortgages, you�re way ahead of the game. In a nutshell, riskier loans mean higher interest rates; you compensate the person lending you money by paying them a higher interest rate. If you have low FICO scores, this is a higher risk to the investor since you don�t have a good history of paying your bills on time, so you�re going to have to pay a higher rate. If you can�t verify enough income to qualify for the loan, this is a higher risk and you�re going to have to pay a higher interest rate.
As it relates to this discussion, the longer you ask the lender to guarantee your interest rate, the higher risk for them since they�re guaranteeing the rate you get but they don�t know how much their funds are going to cost them going forward. This isn�t an easy concept to wrap your mind around, so don�t feel bad if you don�t get it yet. Lenders work on a concept called arbitrage, which is a fancy way of saying they borrow money at a certain rate and then lend it out to you. However, lenders don�t get money at 30-year fixed rates, so when they borrow money they have to try to gauge what it�s going to cost them over the time they lend it to you. If you�re following me so far, you can understand why they would charge a higher rate to guarantee you a certain rate for 30 years as opposed to 3 or 5 years. Now, on to our discussion�
On the one hand, we have fixed rate advocates. These days, this is a relatively easy argument to make since rates are at 40-year lows. The main reason to get a fixed-rate mortgage, whether it be a 15-, 20-, or 30-year fixed, is to protect yourself from adjustable interest rates. When you get a fixed rate loan, you know exactly what your payments are going to be and they�re not going to change for the life of the loan. In a time when rates are rising, a fixed rate mortgage gives you the security of knowing that you�re safe.
On the other hand, there are the adjustable rate advocates. The main argument here, in a nutshell, is that you shouldn�t pay for something you don�t need. A great majority of people out there will only keep their mortgage for 3-5 years. Maybe it�s a job change, maybe it�s an expanding or contracting family, a refinance for home improvements or college for the kids, or any number of life circumstances. Since you�re probably not going to keep your mortgage for 15 or 30 years, you�re probably better off to get a lower adjustable rate mortgage and pocket the difference.
I�m not going to say one argument is better than the other. There�s no such thing as a �good� or �bad� loan, but there are loans that are better or worse for certain people. In my career as a mortgage consultant, I can tell you that I�ve done very few fixed rate loans. I only recommend them in two cases � when people are on a fixed income and need to know exactly what to expect from their mortgage, or when people are absolutely sure that they�re not going to move or need to refinance for many, many years. In a great majority of cases, people don�t need a fixed rate loan and would in fact be much better off with a loan that accomplishes their goals and saves them money in the long term. Like oranges vs. apples or Letterman vs. Leno, fixed vs. adjustable is not a debate that can be definitively settled, but I hope I�ve helped you figure out which one may be right for you.
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