July 19, 2018
Fixed or Adjustable Rate Mortgage – Which one should you choose?
What is a fixed rate mortgage?A fixed rate mortgage is what most people think of when they think of a classic home loan. Depending on the home loan program you choose, you could have a variety of rates, or terms including a 15- year mortgage or a 30- year mortgage at a fixed interest rate. Fixed rate mortgages lock you into the rate you applied at for the life of the loan. That means if you took out your loan and were approved at a certain mortgage rate, it will stay the same until your home loan is paid off. Your monthly Principal and Interest payment will never change and your rates will never go up.
What is an adjustable rate mortgage?And adjustable rate mortgage is a mortgage with a variable rate that may change based on fluctuations in the market after a certain period of time. Usually Adjustable Rate Mortgages – or ARMs – start out with a fixed rate for a certain period of time, then have the potential to change based on what the market is doing. Usually, these loans are expressed with a set of numbers, the first being the amount of time the loan has a fixed rate for, and second being the number of times the interest rate may adjust in a year following the fixed rate period.
For example, a 10/1 ARM is a home loan that has a fixed rate for the first 10 years. After 10 years, the rate will adjust at a frequency of once per year. Rates adjust based on benchmark interest rates such as LIBOR – or the London Interbank Offered Rate – which is a market indicator. If the benchmark rate goes down, your monthly payments could go down, based on the terms of your mortgage. Many ARMs set a cap on high and low interest rates, so your monthly payment would always stay within a certain range.
So which one should you choose?There are many things to consider when choosing your type of mortgage. At first glance you may think fixed rate is the way to go, as it is the most popular type of loan. But some of the pros and cons may surprise you. Check out the list below
Pros of a Fixed Rate Mortgage· Your rate is locked in and will never change – this stability is great for many home owners. If rates start to creep up after you buy your home, your mortgage will not be affected. The rate that you started with is the rate that you’ll end with.
· Your monthly payment will never change – because your rate is fixed, your monthly mortgage payment will always stay the same (keep in mind that your tax and insurance portion of your monthly payment will most likely change from time to time). This can be nice, as there are no surprises and budgeting for the future becomes easier.
Cons of a Fixed Rate Mortgage· Your rate is locked and will never change – now for the flip side of the fixed rate coin. If you purchased a home with a fixed rate and then rates in general decrease, you may end up feeling like you’re missing out, stuck with a higher rate.
· Your rate may be higher than the initial fixed rate of an ARM. Many times, the intital fixed rate of an ARM can be lower than that of a Fixed Rate Mortgage. If you plan on staying in your home for only a short period of time (think 10 years instead of 20-30) it may be wiser to forego the Fixed Rate Mortgage in favor of a lower rate ARM.
Pros of an Adjustable Rate Mortgage· Your rate could end up lower – if rates overall start to decrease, your ARM may be adjusted to a lower rate and you may end up with lower monthly payments.
· If you’re planning on staying in your home for only a short time, you may be able to take advantage of the often lower rate during the fixed rate period of the loan. With our same 10/1 ARM example, if you sold your home after 10 years, you’d be getting the benefit of a potentially lower initial rate without the risk of it adjusting higher later.
Cons of an Adjustable Rate Mortgage· If you plan on staying in your home for more than the fixed rate portion of your ARM, you may run into a scenario where your rate increases. As we mentioned, many ARMs have caps set to keep the loan at a reasonable rate, but your monthly payments may still end up being higher than they originally were.
· Your monthly payments are likely to change – sometimes having flexible payments can make it hard to budget for the future, as you may pay more one year than you had the year before.
All in all, whether you choose a Fixed Rate Mortgage or an Adjustable Rate Mortgage is up to you and depends on your unique scenario. One of our loan professionals will be able to talk over your options if you’re having trouble deciding which option would suit you best. There’s a lot to consider when choosing a mortgage, don’t go it alone. Let us help you get home smarter!