Adjustable vs. Fixed Rate Mortgages
So, you’ve decided to buy a home! With the house selection process behind you, your next major hurdle is to determine which mortgage best suits your long-term financial goals. There are several things to consider—adjustable-rate or fixed-rate, government-insured or conventional and, possibly, jumbo or conforming. Today, Mountain America Credit Union explains the pros and cons of an adjustable-rate mortgage (ARM) and a fixed-rate mortgage.
As complicated as the loan process may seem, this decision shouldn’t be. Let’s break it down.
What is a fixed-rate mortgage?
With a traditional fixed-rate mortgage, the amount of prinicipal and interest paid may vary slightly from month to month, but the interest rate remains the same over the life of the loan. This enables fiscally responsible homeowners to calculate and budget for their long-term house payment. (Wondering what your home loan payment will look like? Try using our instant rate quote tool.)
The advantages of a fixed-rate mortgage are pretty simple: you’re protected from sudden changes in interest rates. This means your payment will remain virtually the same over the life of your loan. From time to time, due to changes in property taxes and your escrow account, your payment may have a slight increase or decrease. Plus, fixed-rate mortgages are pretty straightforward and, consequently, easy to understand.
Be aware, however, that higher interest rates can make monthly payment options on a fixed-rate mortgage less appealing. If you can’t bring the typical 20% down payment to closing, you may find you’re unable to qualify for an afforable fixed-rate mortgage.
One way to avoid surprises at the closing table is to get prequalified when you first start looking for a property. Get the chance to work out all the issues while searching for your dream home, then, when you’re ready, you already know you’ve got the mortgage.
What is an adjustable-rate mortgage (ARM)?
An ARM offers a less traditional approach to buying a home. These loans include a period of time during which the interest rate is fixed. After that, the rate is determined by an economic indicator. For example, an “ARM 5/1,” would have a set rate for the first five years of the loan, and then a new rate every year after that.
ARMs are easier to qualify for, and might enable borrowers who don’t have a 20% down payment to still get into the home they want. Once they’ve built some equity and savings, homeowners can refinance to obtain a better fixed-rate mortgage.
And, because ARMs are a lower risk for lenders, homebuyers can qualify for significantly lower interest rates during the fixed term of the loan. This makes them a solid choice if you plan to sell your home within the fixed term, before rates begin to fluctuate.
On the other hand, if plans change down the road and you decide to stay, or you have trouble selling your home, you could quickly find your initial savings erased by an upsurge in interest rates. The variability of an ARM makes it a higher risk for homebuyers who may end up staying past the fixed-rate period. Be sure you’ve considered your 5-year plan before signing on the dotted line.
Still on the fence about which loan type is best for you? Talk to a mortgage expert to get a comparison on a fixed-rate loan vs. an ARM and determine which will best meet your current and future needs. Then tackle the other mortgage decisions and make that dream home yours!
Get more information on additional mortgage loan options from Mountain America.
