The standard mortgage historically has been a 30 year fixed rate loan. There are wide variety of other loans available and it can be a good idea to understand your long term financial goals before you decide on a loan.
One of first decisions to make is whether you want a fixed rate or an adjustable rate. A fixed rate loan makes it easy to predict your monthly housing costs because the payment is the same over the life of the loan.
Payments on an adjustable rate loan will change over time. This makes it more difficult to predict how much the loan will cost each month. Generally these types of loans have a period of time where the rate is fixed and then after that the rate will change based on an index.
One of the reasons that banks began to offer adjustable rate loans was the high interest rates we saw in the late 1970’s and early 1980’s. According to Freddie Mac, the average rate on a 30 year fixed mortgage almost doubled between 1977 and 1981. In 1977 the average rate was 8.85% and in 1981 the average rate was 16.63%.
The average rate for a 30 year loan in 2002 was 6.54%. It’s been climbing slowly over the last few years but rates are still very low.
A 30 year fixed rate mortgage gives you long term protection against rising interest rates. Even if the rate climbs back to the levels we saw in the 80’s, your payment doesn’t change.
But you pay for this with higher rates. Let’s take a look at the difference between the introductory rate on a 5 year adjustable rate mortgage and a fixed rate 30 year loan. In 2005, the average rate for a 5 year ARM was 5.32% but in that same year the average rate for a 30 year fixed rate was 5.87%. That’s almost a half percent point higher.
The 5 year ARM will only have that rate for 5 years. After that the rate will go up or down depending on whether the index it’s tied to goes up or down. Given that interest rates are so low, you should probably count on the rate for your ARM going up over time.
If you want to look more at your specific numbers, check out our mortgage calculators so you can see what your specific situation will look like.
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