Adjustable vs Fixed-Rate Mortgage: Which One Should You Choose?

5 Things to Know About Fixed-Rate or Adjustable-Rate MortgagesThere are a lot of mortgage options that home buyers need to consider. One of the first comparisons they may make is adjustable vs. fixed-rate. Although many people believe fixed-rate to be the gold standard of mortgages, there are plenty of reasons to consider both choices. This can be a very important part of home buying, so people should invest the time to research all opportunities before making a choice. Here are several factors home buyers should think about as they browse, with pros and cons for each.

For informational purposes only. Always consult with a licensed mortgage professional before proceeding with any real estate transaction.

1. Features of Fixed-Rate Mortgages

Fixed-rate mortgages are often easier for new home buyers to understand. Once they sign the paperwork to close on the loan, the interest rate remains the same until it is paid off. This offers home buyers the benefit of knowing that their monthly payment for principal and interest will not change. The interest rate of the mortgage tends to be higher than the initial rate for an adjustable-rate loan, but this depends on a few different factors. Fixed-rate mortgages tend to come in a greater variety of term lengths. This means that a buyer considering a fixed-rate loan might be able to choose a term of:

  • 15 years
  • 20 years
  • 30 years
  • 40 years

Each one has different requirements and average interest rates.

2. Factors Unique to Adjustable-Rate Loans

Unlike a fixed-rate loan, an adjustable-rate mortgage will change interest rate over time. The variability means that the interest rate might go up or down significantly over the life of the loan, or hardly at all. As a general rule, adjustable-rate mortgages start out with an initial term in which the interest rate is fixed, usually 3-10 years. During this time, the monthly payment for principal and interest are set.

After that period ends, the rate will adjust based on a specific index. The amount homeowners need to pay for principal and interest changes to accommodate the interest rate. The rate will continue to reset on a set term, typically 6-12 months. It often goes up but can go down, depending on factors related to the mortgage market. Most loans also have a maximum amount that the interest rate can rise or drop each time it resets.

3. Buying Power

As a general rule, adjustable-rate mortgages tend to be easier for home buyers to secure. The initial rate for an ARM is typically lower than a fixed-rate mortgage, although it usually goes up over time. This means that a homeowner with an ARM may have a lower monthly payment at the beginning. Since the monthly payment determines how much someone can get for a loan, it may significantly affect their buying power. People who live in areas with a higher cost of living might have to go with an adjustable-rate loan by default simply because they cannot get a loan large enough otherwise. This is often true for home buyers with a low down payment, or who have a modest income, as well.

4. Convenience Now vs. Future Stability

Although the adjustable-rate mortgage offers a lot of benefits for people trying to get their foot in the door, it requires a greater understanding of the terms of the loan. With a fixed-rate loan, the rate never changes. This means that even if the loan is sold to someone else, the principal and interest remain the same.

By comparison, an ARM features flexibility that people can use to their advantage, if they know how to plan ahead. For example, a 7/1 ARM will keep the same rate for seven years, then adjust once a year after that. Someone who knows they will need to sell the house in five years can get the benefit of the lower interest rate, without ever having to deal with the rate changes.

5. How to Decide

Fixed-rate mortgages tend to get framed as the choice everyone should take if they can, but the truth tends to be more individual. People who want a mortgage with a less-common length, like 15 or 40 years, may only be able to choose a fixed-rate loan. In many cases, the consistency and predictability of this mortgage becomes a long-term benefit. For home buyers who need more flexibility in the mortgage payment, an adjustable-rate loan is a reasonable consideration. Someone who needs to move or plans to refinance before the end of the initial term could save hundreds or thousands of dollars with an ARM instead of going for a fixed rate.

Choosing between a fixed-rate and adjustable-rate mortgage may be one of the first big Eagle Ridge home buying decisions that people make during the process. They both offer convenience, depending on what homeowners need most. By carefully examining their options, people are more likely to settle on the choice that is best for them.

For informational purposes only. Always consult with a licensed mortgage professional before proceeding with any real estate transaction.

Post a Comment