After acquiring a mortgage, there are many loan features to consider. One of the most important decisions is whether to go with a fixed or adjustable rate mortgage. Of course, each of them has their own benefits and drawbacks, which means your decision will most likely be based on your budget, housing needs, and the risk you’re willing to take.
Boiled down, a fixed rate mortgage has the same interest rate for the life of the loan, so your monthly payment of principal and interest wont change.
This is the most popular type of financing because it offers predictability and stability for your budget. The lenders for a fixed-rate mortgage typically charge a higher starting interest rate than they do for an ARM, which can limit how much you can afford.
- Rates are constant despite what happens in the broader economy
- Stability makes budgeting easier
- Simple to understand and great for first-time buyers
- If interest rates fall, fixed-rate mortgage holders have to refinance to take advantage of that as well as pay borrowing fees and costs all over again
- Are mostly identical from lender to lender and generally cannot be customized
- Can be difficult to qualify for with higher mortgage rates than ARMS
Adjustable Rate Mortgage:
An adjustable rate mortgage, or ARM, is a home loan with an interest rate that can change periodically. Usually, the initial interest rate is lower than that of a comparable fixed-rate mortgage. After the fixed-rate period ends, the interest rate on an ARM loan moves based on the index it’s tied to.
For example, the most popular interest rate is the 5/1 ARM. The 5 represents the amount of years the introduction rate will last and the 1 means the interest can change once a year. Some lenders offer 3/1 ARMs, 7/1 ARMs, and 10/1 ARM’s.
- Features lower rate and payment early in the loan
- Allows borrowers to take advantage of falling rates without refinancing
- Helps borrowers save and invest more money
- Offers a cheaper way for borrowers who don’t plan on living in one place for very long to buy a home
- Rates and payments can rise significantly over the life of the loan
- Harder to understand for first time buyers
- Some annual caps don’t apply to the initial loan adjustment
Now that you know the differences between an adjustable-rate mortgage and a fixed-rate mortgage, you should have a better understanding of which option works best for you based on your situation. Remember to consider these important questions when deciding which loan is best for you.
- How long do you plan on staying in the home?
- How frequently does the ARM adjust, and when is the adjustment made?
- What’s the interest rate environment like?
- Could you still afford your monthly payment if interest rates rise significantly?