Fixed Rate vs Variable Rate Mortgage -- Factors to Consider When Choosing a Mortgage in 2023

Buying a home's probably one of the biggest investments you'll make in your lifetime, and a crucial part of making that investment a success is the type of mortgage that you choose. So if you wanna make that investment a success and avoid potentially making one of the biggest financial mistakes of your life, then you need to understand the differences between the different types of mortgages, and I'm gonna break that down for you, including the pros and cons of each type, in this video. This is Austin Klar, your lawyer turned real estate agent and real estate developer in San Francisco. I've lived in multiple neighborhoods all across the city, giving me in-depth firsthand knowledge of what it's like to both live and work in San Francisco. If you're thinking about buying or selling a home or you want more information about the market, definitely reach out to me. My contact information's in the description below. I will personally answer every call, every email, every text, and I would be more than happy to help you. And if you like videos just like this, please consider subscribing to my channel and don't forget to click the bell so you're alerted every single time I post a video. All right, so this video is all about the differences between the two general types of mortgages, fixed-rate mortgages and adjustable-rate mortgages. Now, there are a lot of different factors to consider and every situation is going to be unique. So I highly recommend that you talk to a trusted lender about your situation of what your different options are so that they can guide you and give you information necessary to make the best decision for your circumstances. If you don't already have a trusted lender in the area that you're looking to buy a home, definitely reach out to me. I'd be happy to refer you to one. All right. So first up is the fixed rate mortgage, and it is exactly what it sounds like. The rate that is quoted in the mortgage is fixed for the entire life of the loan. If it's a 15-year fixed mortgage, the interest rate is fixed for the entire 15 years. 30-year fixed mortgage, same thing, fixed for 30 years. With fixed rate loans, your monthly total payments won't change, so they are really good for giving predictability and for people who want a stable amount of payment over time. They wanna know exactly what to budget for throughout the life of the loan. That's what a fixed rate loan gives you. The 30-year fixed mortgage is probably the most popular loan type because payments are spread across a 30-year period, so the payments tend to be lower on a monthly basis. You will end up paying more in interest on a 30-year loan than a 15-year loan because the money is outstanding for longer and rates tend to be higher on 30-year fixed loans compared to 15-year fixed loans. But if people are focused on minimizing their amount of their monthly payment and want that stability and understanding from a budgeting perspective what they're gonna have to outlay every single month for the life of the loan, then a 30-year fixed mortgage is likely the right choice. Compare that to an adjustable rate mortgage, which again is exactly what it sounds like. It's a rate that can adjust from period to period over the lifetime of the loan. Loan terms on adjustable rate mortgages, depending on the product, are for the same overall term as fixed rate mortgages. There are 30-year adjustable rate mortgages, or ARMs, just like there are 30-year fixed-rate mortgages. Unlike a fixed-rate mortgage, an adjustable-rate mortgage has an interest rate that can vary over different periods throughout the life of the loan. The initial rate set on an adjustable-rate mortgage, or an ARM, is set below the current market interest rate. If the interest rate on a 30-year fixed mortgage is 6%, maybe the interest rate on a 30-year ARM is going to be 5.5% or 5%. And then as time goes on, that interest rate is going to fluctuate depending on what's going on in the broader market. It can go up or it could go down. There are a lot of different ARM structures out there, and, and you'll see them referred to as a number slash another number. So a 3/1 ARM, 5/1 ARM, 7/1 ARM, or a 10/1 ARM. That first number is the number of years where you get that introductory mortgage rate, the mortgage rate that is lower than what the current market rate is at the time you take out the loan. So if you have a 10/1 ARM, that means your interest rate, your introductory interest rate, is going to be fixed for the first 10 years of the loan. And then the 1 of 10/1 ARM means that your interest rate can adjust every single year thereafter. So if you have a 5/1 ARM, that means the interest rate that you're quoted up front is gonna be the same for the first 5 years, and then every year after that, your interest rate can adjust. The biggest advantage of adjustable rate mortgages is that they tend to be cheaper than fixed rate mortgages because that initial introductory mortgage rate is set below the current prevailing market rate for a —fixed rate product. And in a falling interest rate environment, it means you get to take advantage of those lower rates when the rates start adjusting on your mortgage, uh, without having to refinance your loan. The downside of an adjustable rate mortgage compared to a fixed rate mortgage is the potential that your interest rate actually goes up, not down, after that introductory period. So if you're in an environment with rising interest rates and your initial period expires, the bank is gonna look at what the prevailing market rate is and make an adjustment. Let's say you took out the ARM when interest rates were 3%, your introductory period has expired. Now prevailing current market interest rates for a 30-year fixed product, for example, are 6%. Well, the bank is gonna take that into account and charge you a higher interest rate for that next 1-year period of your loan. And then it's just gonna keep adjusting year over year after that. Now there are limits to how much rates can rise both from a year-to-year period and overall. It's not like you're gonna get hit with a 20% interest rate overnight when your introductory period was a 2% rate. But interest rates can wildly fluctuate depending on what's going on in the broader market, so it's something that you need to be careful of when you're taking out an adjustable rate mortgage. For planning purposes, you need to be able to afford the highest potential mortgage rate you could be subject to under the loan, not the lowest potential mortgage rate. When choosing the right mortgage for you, you need to consider a wide range of personal circumstances and what your goals are for that particular property. And you need to balance that with what's going on or what you think is going to be going on with the broader economic market. Personal finances rise and fall, interest rates rise and fall, stocks rise and fall, the economy rises and falls. So you need to think about all of the different possibilities when you're considering which type of mortgage and what structure. How much can you afford today? If rates go up, are you still going to be able to afford the payment if you have an adjustable rate mortgage? If you can still afford the adjustable rate mortgage when the interest rates hit the cap, then an adjustable rate mortgage is likely to save you some money. Ideally, you would use that extra savings to pay down the principal on your loan so that you're paying less interest over time, but that's up to every individual. You also need to think about how long you're gonna be living on the property. If you think you're gonna be outta there within 5 years, then taking out a 5-year adjustable rate mortgage where that 5-year period has a little bit lower of an interest rate might make sense because you're gonna end up getting a new mortgage anyway after that 5 years when you move on to another property. You also need to think about where interest rates are heading. If you think interest rates are gonna go up, then you might wanna take out a fixed rate mortgage because your rate is going to be fixed at an amount that's lower than where you think the market is headed, say 5, 10, 15 years down the line. If you think interest rates are gonna go down, then maybe you consider an adjustable rate mortgage so that rates can fall after your introductory period. Either situation, you'll be able to refinance if in fact rates fall below where your adjustable rate mortgage or fixed rate mortgage is. So who are good candidates for adjustable rate mortgages? Homeowners whose primary goal are lower monthly payments, or homeowners who probably aren't going to be in their homes for very long. They're more short-term homeowners. Those are gonna be ideal candidates for adjustable rate mortgages. But you definitely need to keep in mind that plans sometimes change. Like me, for example, I thought I was gonna move out of San Francisco back home to Southern California after a couple years, but over 10 years later, I'm still in San Francisco. Things change, jobs change, relationships change. You never truly know what's going to happen. So you wanna make sure that you have eyes wide open when you go into figuring out what type of mortgage you wanna take out. So if you end up staying in your home longer than you think you would, and then interest rates are higher when your introductory period expires for an adjustable rate mortgage, then you could be stuck with a higher interest rate payment than you otherwise would have desired. For people who have relatively stable income, who don't expect to have big bumps in the near future, a fixed-rate mortgage might be more appealing because they have predictability and stability with how much their monthly payment is going to be for the entire life of the loan. If rates end up going down below what your mortgage interest rate is, that's okay. You can refinance your mortgage to take advantage of that lower rate. But if they go up, you locked in a, a lower mortgage and there's nothing you need to do. You're stuck at those lower interest rates. Your payments are fixed for the life of the loan. But if you do expect your income to go up significantly, then an ARM could save you a lot of payments up front, and you can take the extra money that you're earning to pay down your ARM and significantly reduce your interest payments. A buyer who is buying one house and selling their old one at the same time might make sense for them to take out an ARM on that new home and then use cash to pay it off once they have that old home sold. If it's an absurdly low interest rate environment like we saw in 2021 and early 2022, Then go ahead and take out a fixed-rate mortgage and lock in that super low interest rate. If you're buying your forever home and you wanna make sure you can afford payments for the entire lifetime that you're gonna be in that home, then a fixed-rate mortgage also might make sense for you because you have that predictability and stability. You know exactly what it's gonna cost to be in that home for the rest of your life or for the life of that mortgage. These are just high-level examples of, you know, what types of situations fit what types of mortgages. Like I said, every situation is going to be unique, so you definitely wanna communicate your goals to a realtor and communicate your goals to a lender so that you can get the best advice and guidance on what mortgage to take out and how to structure it. If you are thinking about buying a home or want more information about mortgages or the market, definitely reach out to me. My contact information's in the description below. I will personally answer every call, every email, every text, and I would be more than happy to help you. And if you like videos just like this, please consider subscribing to my channel and don't forget to click the bell so you're alerted every single time I post a video.