Fixed-rate mortgages

bank-expert on July 9, 2009 0

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Fixed-rate mortgages are the most common ones, though lenders offer several types of mortgages. The loans feature fixed rates and monthly payments, generally for 15-year and 30-year periods.

Causes of their popularity:

1. Consumers balk at the thought of their house payment falling and rising with interest rates.

2. Whenever rates are not high, fixed-rate mortgages are very affordable.

Fixed-rate borrowers have one important choice: 15-year or 30? For some fixed-rate borrowers, a 30-year loan makes more sense, for others, a 15-year.

Here are some advantages and disadvantages of each.

30-year fixed rate

Advantages Disadvantages
  • Offers the chance to borrow money on a long-term basis without having to worry about the interest rates or payments changing.
  • Monthly payments are lower than those on 15-year loans because the interest is amortized over a longer period.
  • Lower monthly payments free up money that borrowers can pour into investments that yield more than their homes.
  • Higher interest bill increases the amount consumers can deduct at tax time, potentially reducing or eliminating their federal income tax liabilities.
  • Borrowers build equity at a very slow pace because payments during the first several years go largely toward interest rather than principal.
  • The overall interest bill is much higher because of the long amortization term.
  • The interest rates are higher than on 15-year loans.
15-year fixed rate

Advantages Disadvantages
  • Borrowers build equity much more quickly due to shorter amortization schedules.
  • Overall interest bills are dramatically lower than those on longer-term loans.
  • Interest rates are lower than 30-year loans.
  • Monthly payments can be significantly higher than those on 30-year loans.
  • Restricts homebuyers to smaller houses than they might be able to afford with longer-term loans.

Example

Imagine you have a $150,000 mortgage. Look how much money you would pay in interest over 30 years vs. 15 years. The following table shows the numbers. The loan payments for month are principal and interest only. So with a 15-year loan you would save $117,001 in interest.

Interest cost: 30-year vs. 15 year mortgages
Loan term Rate Monthly
payment		 Total
interest
30 years 6.64% $961 $196,304
15 years 6.10% $1,274 $79,304
Interest difference $117,001

Other factors

Look at the example above: With the 15-year loan, the mortgage payment for month is $313 more than the 30-year mortgage. You can put that money toward another investment. For example, in a bull-market economy, you can make more money investing that $313 every month in mutual funds or other investment securities.

Don’t forget that there are ways to prepay your mortgage and whittle away at the principal each month so that the loan is paid off sooner than 30 years.

If you plan to own the home you are purchasing less than five years, you may be better off with an adjustable-rate mortgage, or ARM.

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