Fixed vs. adjustable rate mortgages
Both fixed and adjustable rate mortgages have their own benefits, but one may make more sense for your financial situation. Learn more about the differences between the two so you can decide which mortgage loan option is best for you.
Mortgages aren’t "one size fits all." And to get the one that’s best for you, it’s important to understand what makes them all different. To keep this simple, we’re just going to focus on two different kinds of mortgages: a fixed-rate mortgage, and an adjustable-rate mortgage. While there are a lot of different kinds of mortgages within those categories, figuring out which of these two types best suits your needs is a good place to start.
A fixed-rate mortgage is exactly what it sounds like. It’s a mortgage that keeps the same rate for the entire life of the loan, typically 15- or 30-year terms. So let’s say you take out a 30-year fixed-rate mortgage with a $2000 monthly payment this year. You’ll still be making that same payment of principal and interest 10, 20 and 30 years down the line.
Then there are adjustable-rate mortgages, also known as ARMs. These mortgages have interest rates that can change depending on market conditions, meaning that your monthly payment can go up or down. The most popular type of ARM taken out today is a fixed-period ARM, also known as a hybrid ARM. They’re based on a 30-year term and typically start with an initial fixed-interest rate for a specific period of time, usually 5, 7 or 10 years. For example, a five-year ARM will be referred to as a 5/1 ARM, and its interest rate will stay the same for the first five years. Because the interest stays the same for five years, the monthly payment of principal and interest will also stay the same for this time period. But after that fifth year, the interest rate is subject to change annually for the remaining 25 years left on the mortgage. The rate will change based upon changes in the current financial market, and that means that your monthly payments will change based on the interest rate applicable at the time of adjustment. So make sure that you’re prepared to make higher monthly payments if interest rates rise.
So which of these loan types is best for your situation? Asking yourself some key questions can help you figure it out. One – do you want the predictability of knowing what your principal and interest payments will be year after year? Two – are you planning to stay in your home for a long period of time? And three – do you want protection from rising interest rates in the future? If you answered yes to any of these questions, a fixed-rate mortgage may offer you the stability and predictability you need, especially if this home is where you plan on raising your family or retiring.
And now a few questions to help see if an ARM offers what you need. One – is this a starter home, or one that you aren’t planning to stay in for a long period of time? Two – do you believe that interest rates might go down in the future? And three – will you be able to afford your payments when the fixed-rate period is over and the rate resets- and possibly goes up? Now, if you answered yes to any of those questions, then an ARM might give you the biggest bang for your buck in the short term. That’s because many times the interest rate during the fixed period of the loan will be lower than what you’d typically get with a fixed-rate loan.
So when it comes to buying a home, whether now or in the future, it’s important to know the ins and outs of getting the right mortgage. What’s more, you need to have your financial house in order before you get started, so work out a budget. Look up current interest rates. Run some numbers using an online mortgage calculator. And be sure to be honest with yourself about how much home you can really afford. Because you’re not only setting out the welcome mat for a happy home, you’re making a financial commitment for many years to come.