Fixed vs. Adjustable Rate Mortgages
When purchasing a home, one of the most important decisions you face is what type of loan to go with. There are many different options to consider and you will need to decide whether to take out a fixed or an adjustable rate mortgage. The type of mortgage that’s right for you depends on many factors, such as your tolerance for risk and how long you expect to stay in your home.
Fixed rate mortgages
With a fixed rate mortgage, the interest rate on a fixed rate mortgage remains the same throughout the life of the loan. Your monthly payment (consisting of principal and interest) generally remains the same as well. The entire mortgage is repaid in equal monthly installments over the term (length) of the loan.
Fixed rate mortgages are the most popular and almost 75% of all home mortgages are fixed interest rate mortgages. However, having a fixed interest rate on your mortgage has both positive and negative aspects. If interest rates rise, yours won’t; and thus, your monthly mortgage payment will always remain the same. For homeowners on tight budgets or with fixed incomes this can be reassuring and this type of mortgage is typically the best choice.
On the other hand, if interest rates go down, yours will not, and your mortgage payment will remain the same. However, a possible option may be to refinance your home, paying off the higher-rate mortgage with one that carries a lower interest rate. Keep in mind the interest rate might need to drop significantly to offset the expenses associated with refinancing, and you’d need to remain in your home long enough to recoup those expenses.
Adjustable rate mortgages (ARMs)
With this type of mortgage, sometimes also called a variable rate mortgage, your interest rate is adjusted periodically, rising or falling to keep pace with changes in market interest rate fluctuations. Your monthly payment amount is recalculated with each rate adjustment. Depending on what’s specified in the mortgage contract, an ARM can be adjusted semi-annually, quarterly, or even monthly, but most are adjusted annually.
Adjustable-rate mortgages come with special rules (rate caps) that limit how much your payment can increase. These rate caps are important because they protect you from unlimited higher payments, no matter how high or how quickly market interest rates rise.
If you are uncertain as to if an ARM is for you, consider if the following apply to you:
Want or need more home than you can qualify for now at a fixed rate.
Are confident your income will increase.
Plan on moving within seven years of buying your home.
You can tolerate uncertainty in your mortgage interest rate and fluctuations in your monthly mortgage payment amount.
There are many different types of ARM mortgages and although somewhat riskier than a fixed rate mortgage, an ARM may benefit you if you have certain needs or find yourself in certain circumstances. Depending on your situation, you may be better off with a fixed rate or other type of mortgage. Examine your financial and life situation with the help of your loan officer or financial advisor. Try this mortgage calculator to help you in your decision making.
