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What
is a fixed rate loan?
With a fixed-rate loan, your monthly
payment of principal and interest never change for the life of your
loan. Your property taxes may go up or down (well – probably not
down), your homeowner's insurance premium (part of your monthly
payment) may change over time, but generally with a fixed-rate loan
your payment to the bank will remain the same.
Fixed-rate loans are available in all sorts of shapes and
sizes: 30-year, 20-year, 15-year, even 10-year. Some fixed-rate
mortgages are called "biweekly" mortgages and shorten the
life of your loan. With a
“biweekly” you pay every two weeks, a total of 26 payments a year
-- which adds up to an "extra" monthly payment every year.
Whatever the shape or size, you must choose it at the beginning
of the loan.
For all fixed rate loans, during the early years of the
loan, a larger percentage of your monthly payment goes toward the
interest and a much smaller part goes to pay down the principal. That
gradually reverses itself as the loan ages.
What shape or size is the best?
For most of us, monthly cash flow and financial flexibility
considerations will determine the shape and size of our loans.
For example, a 30-year fixed rate loan for $100,000 with a
6.25% interest rate will have a monthly payment of $616/month.
During the 1st 10 years of this loan, you will pay
about $58,000 in interest. On
the other hand, a 15-year fixed rate loan for $100,000 will usually
have a lower interest rate (about .25%/month cheaper), but the monthly
payment will be higher at $844/month. During
the 1st 10 years of the 15-year loan, you will pay about
$46,000 in interest. With
these loans, the 15-year fixed rate loan looks like it “saved”
$12,000 in interest. However, it cost you an additional $27,360 to “save” the
$12,000 in interest. The
$27,360 isn’t really lost, but it is locked-up in your home’s
equity.
Herein lies the rub. Do
you opt for a lower interest rate in lieu of future flexibility? The
increase in cash flow from a lower payment creates options.
You can invest the difference at a potentially higher rate of
return, increase contributions to retirement accounts, cover
unexpected needs for future cash flow issues, or, if the extra funds
are not needed, you can pay down the principal reducing both the
amount of interest you pay over the life of the loan and the length of
the loan.
The shape and size of your loan is an important and
complicated financial decision and there are many options to consider.
You should, at a minimum, ask your tax advisor, your financial
planner (certified) and your loan broker for their opinions before
making a final decision about which loan is “best” for you.
Remember to look at the big picture to determine how other
areas of the financial planning process are affected.
Why would anyone choose a fixed-rate loan?
If interest rates are on the rise, a fixed-rate loan will
offer payment protection. Unlike
an adjustable-rate loan where payments will continue to increase
during periods of rising interest rates, fixed-loan payments will not
increase. If interest
rates continue to rise, a fixed-rate loan may be cheaper in the long
run because you have “locked-in” a lower payment.
If you are currently in an adjustable-rate loan, consider
refinancing if it appears that higher interest rates will prevail in
the future.
What
should all consumers know about fixed-rate loans?
Fixed
rate loans are fairly simple with not many pitfalls. The biggest problem with all loans is the inherent conflict
of interest between a lender and a consumer.
Your “friendly banker” may have the highest rates in town
because he makes loans for one purpose -- to make money for the owners
of the bank. While a
lender is obligated to disclose all the terms of the loan you are
considering, the lender is not obligated to tell you how to save money
in a particular transaction.
Because of the inherent conflict of interest between lenders and consumers, we believe all consumers should consider using the services of a loan broker who has no financial “stake” in the lender.
If You Desire More Time to Pursue Life's Pleasures, Find Out How a Certified Financial Planner Can Help.
Click Here for more information on financial planning and The Financial Planning Center
Contact: ProActive Financial Planning
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