There are different types of expenses that we incur in our daily lives and sometimes taking a moment to analyze them can help manage them better.
A mortgage is one of the main expenses many individuals have to deal with monthly and it can be a fixed expense or a variable expense.
Is a Mortgage a fixed expense? Mortgages are fixed expenses because they do not fluctuate or increase over time. However, a mortgage can be a variable expense when a person opts for an Adjustable mortgage rate and the interest fluctuates after the introductory period.
Lowering expenses is one of the components of achieving the financial independence we all want. It makes it easier to save and should result in a surge in your savings.
However, lowering expenses takes some commitment at a personal level and you might have to make some lifestyle changes to achieve the milestones but it is usually worth it.
Mortgage as a Fixed Expense
In any person’s monthly budget, there are fixed and variable expenses. The fixed expenses are repetitive and you can comfortably predict them because they don’t change over time. These include;
- insurance premiums
- vehicle lease
- pension contributions
People with mortgages have to pay a similar amount monthly according to the loan agreement.
However, a mortgage can become a variable expense when a person opts for an adjustable-rate mortgage instead of a fixed-rate mortgage.
Variable expenses are those that vary over time and are difficult to predict without incurring them first. They will often represent the spending decisions we make daily. The common examples are groceries, utility bills, car repairs, electricity bills, and others.
An adjustable-rate mortgage normally has a fixed interest rate or “introductory rate” for some time, after which it can fluctuate. The rate can change yearly, quarterly, or even monthly after the period. So, until the rates start fluctuating, an adjustable-rate mortgage can qualify as a fixed expense.
Pros and Cons of Fixed-rate mortgages
Most people who buy a house using mortgages will go for the fixed-rate mortgage because you know how much you’re expected to pay every month which can provide significant peace of mind. Some of the other advantages include;
- You remain protected in case interest rates go up.
- A fixed rate is easy to comprehend.
- With stable rates, it’s easier to compare lenders before making your decision.
However, there are also some downsides to fixed-rate mortgages such as;
No benefits when interests fall
Even when the interest rates go significantly low, mortgages with fixed rates remain constant. So, users cannot enjoy these rates unless they choose to refinance their loans which can be a lengthy process. Furthermore, after refinancing you will still have to pay the closing costs associated which can range between 2% to 7% of the total value. That can translate to thousands of dollars.
No introduction rate
Fixed-rate mortgages do not offer an introductory rate for the first few years. The introductory rate is a teaser interest rate offered with an adjustable-rate mortgage and grants the borrower a lower interest rate for the first few years. However, this is a temporary disadvantage since, in the long term, the stability of fixed-rate mortgages is encouraging.
What Is the Appeal Behind Adjustable-rate mortgages?
An adjustable-rate mortgage or ARM starts by offering a low “teaser” interest rate which can range between 3 to even 10 years. After that period, there can be interest rate adjustments either monthly or even yearly. So, why do people sometimes choose ARMs?
You aim to own the house for a short time
When purchasing a house, people have to decide whether that is where they see themselves spending the rest of their lives. Some people take mortgages knowing that the home is a temporary housing solution for example for 3- 10 years. A good example is doctors in residency or military families.
So, here the borrower can decide to choose an ARM that has an introductory rate that covers the maximum time they see themselves spending there. From there they can relocate. In this case, it will be a lot cheaper than a fixed-rate mortgage over the same period.
You see yourself paying off the mortgage quickly
For another person, an ARM might be an attractive option if they expect to be done paying it early. If a person expects some financial windfall such as a major raise, a settlement from a lawsuit, or even an inheritance, in the next few years, they might opt for an ARM. You are likely to pay less monthly until you can own the home.
When Expecting Fixed-rate mortgages to Decrease
This is risky and rates are hard to predict. However, some people are confident in their abilities to predict when the fixed rates will go down to become lower than the ARM rates before the introductory period expires. Normally, fixed-rate mortgages have higher interest rates but they sometimes do fall and if a person can correctly predict this drop they can save some money.
It will require them to refinance their loans and switch to a fixed-rate mortgage when the drop is appealing to them. The process will involve, finding another lender, getting approved again, and paying new closing costs for the new loan, just like you did with the ARM. However, you will benefit from lowered interest rates throughout the entirety of your mortgage.
Note: An Adjustable-rate mortgage is a bad idea if;
- You are buying a forever home. If you are purchasing a home with no plans of moving, you should consider a fixed-rate mortgage.
- You prefer predictable mortgage payments. If you are not a fan of fluctuating payments, then a fixed-rate mortgage is the better choice for you.
- Your Budget is not flexible enough to handle larger mortgage monthly payments.
Choosing between a fixed-rate and an adjustable-rate mortgage will often come down to you. You need to assess your plans for the future and take your financial position into your account. Simply put, ARMs can be cheaper but they are the riskier option.
Fixed expenses are easy to manage since you can estimate and anticipate them. However, for a person looking to increase their savings, variable costs are often where you can cut back. It can be challenging sometimes and will some discipline and sometimes even a lifestyle change. Sometimes getting a financial advisor might be the best solution to save funds in saving funds and cutting costs.