Adjustable or Fixed? That’s one of the decisions you’ll need when considering a new mortgage either for a purchase or for a refinance. When rates are at relative lows and the expectation is to keep the property well into the future it can make sense to latch onto a fixed rate loan. A fixed rate loan is much easier to budget for as the home owner knows how much the mortgage payment will be throughout the life of the loan. It’s easier to plan for. Pick out a fixed rate term, lock in the rate and forget it. But does that mean an adjustable rate mortgage is rarely an option? Should borrowers ever even consider a variable rate loan? The answer, even in times of low rates, is yes. There are times when an adjustable rate mortgage can be beneficial.
Adjustable rate home loans can have an interest rate change at various points throughout the life of the loan. For a 1-year loan adjustable rate loan, the rate can change once per year based upon a preselected index and an added margin. If the index was 1.25 and the margin on the loan program was 2.00, adding the two together would result in an interest rate of 3.25% and would remain there until one year later. To protect the borrowers against any wild swings in the interest rate from one year to the next, adjustable rate loans have interest rate caps. If the rate cap is 2.00%, no matter how high or low the index would be one year later, the rate could not move more than the cap dictates. Borrowers select adjustable rate loans because the start rate is lower than what is found on fixed rate loans. That’s the advantage. Even if rates in general begin to climb over time, due to the caps in place it limits the movement of the rate and therefore the payment.
Today, most adjustable rate programs are found as hybrids which means the start rate on the loan is fixed for a predetermined period of time before turning into a loan that can change once per year. The most common hybrid is the 5/1 where the rate is fixed for five years. Other hybrid options include 3/1, 7/1 and 10/1. Hybrid start rates are also lower than fixed rate loans and can be a beneficial option, lowering monthly payments.