Fixed Rate Vs. Adjustable Rate Mortgage

What Is A Fixed Rate Mortgage?

A fixed-rate mortgage is a home loan in which the interest rate is locked in for the term of the loan. For example, if you get a 30-year fixed-rate mortgage with a 7% interest rate, your rate will remain 7% until your loan is either paid in full or refinanced, regardless of changes in going market rates.

The Benefits: Many homebuyers choose a fixed-rate mortgage because of payment stability. With a fixed-rate mortgage, your principal and interest remain the same for the duration of the loan. This makes budgeting easier since you know what the payments will be. Although it’s impossible to forecast if rates will rise or fall in the future, a fixed-rate mortgage helps protect you from an increase in rates. If you want to pay off your loan sooner, you generally have the option to make additional principal payments too.

The Cons: The drawback is that your initial rate could be higher with a fixed rate than what you would pay on an adjustable rate. There is also a chance that rates could go down, leaving you locked in at a higher rate. However, as long as you maintain solid credit, income, and debt levels, you should be able to refinance your loan to get a lower going rate if they were to go down.

What is An Adjustable Rate Mortgage?

An adjustable-rate mortgage (ARM) is a loan in which the interest rate may change periodically, usually based upon a pre-determined index. The ARM loan may include an initial fixed-rate period that is typically 5 to 10 years. The interest rate can/may change (adjust) each year thereafter once the initial fixed period ends. For example, with a 5/1 ARM loan for a 30-year term, your interest rate would be fixed for the initial 5 years and could fluctuate up or down each subsequent year for the next 25 years.

The Benefits: ARMs usually have a lower initial interest rate when compared to a fixed rate, but remember that the rate will reset. Many homebuyers consider this type of rate attractive because of the initial lower payment, which could help them get a larger loan amount. This mortgage allows you to convert it into a fixed rate once the introductory period elapses. If the economic situation seems less certain, this option is convenient. On the other hand, you can stick to the arrangement if the economy is pretty predictable, giving you the confidence of consistency.

The Cons: The potential downside to an ARM is that your rate would go up if market rates increase. This would mean a sudden increase in your monthly mortgage payments. And, depending on the severity of the rate change, the payment increase could be steep. This can make it difficult to budget accurately.     

The Bottom Line: This is a huge decision, so be sure to connect with a reputable lender who will be able to guide you on the right type of mortgage for your situation. Key questions you would need to consider are: How long are you planning to stay in the home? How will you plan your housing budget if you get an ARM and the rates rise? At the end of the day, whether you choose a fixed-rate mortgage or an ARM, don’t be enticed into borrowing more than you can afford. Plan on what fits your budget and goals.

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