Fixed-Rate Mortgage vs. Adjustable-Rate Mortgage

Mortgages come in all shapes and sizes, and it's important to have a good understanding of how different types of mortgages and loan terms can impact your financial goals. One key decision to make is whether to go with a fixed-rate mortgage or an adjustable-rate mortgage. Both have benefits and drawbacks, and the decision you make should be guided by your budget and housing needs.

What Is a Fixed-Rate Mortgage?

A fixed-rate mortgage is a home loan with a fixed interest rate that remains the same throughout the life of the loan. In other words, your principal and interest payment (P&I) will never change. Keep in mind other parts of your monthly mortgage payment, like property taxes and homeowner's insurance, can still have fluctuations.

A fixed-rate loan is a popular choice for home buyers because it provides predictability and financial stability. You know exactly what your P&I payment will be, and it will remain the same for the life of the loan. Common fixed-rate loan terms include 30-year mortgages and 15-year mortgages.

Pros of a fixed-rate mortgage

  • Rates and monthly payments stay the same.
  • Predictable payments provide stability and make budgeting easier.
  • Fixed-rate mortgages are easy to understand.

Cons of a fixed-rate mortgage

  • If interest rates drop, buyer's remorse can hit. The only way to lower your interest rate is to refinance, which means you'll need to pay closing costs again.
  • You could end up paying more over the life of the loan if you lock at a higher interest rate and don't refinance.

What Is an Adjustable-Rate Mortgage?

An adjustable-rate mortgage, or ARM, is a mortgage loan with interest rates that can fluctuate. This means your interest rate and monthly payment can go up and down throughout the life of the loan. The good news is that these rate changes aren't at random - you'll be agreeing to specific terms.

ARMs begin with a set interest rate for a specified period of time. After that time, the rate is periodically adjusted. The secret to deciphering when an ARM will adjust can be found in its name. For example, a 5/1 ARM means your rate will be fixed for five years, then adjusted annually. The most common ARM terms have fixed-rate periods of three, five, seven, or ten years.

Typically, ARMs have lower interest rates than fixed-rate mortgages at the start of the loan. The catch is that they will reset multiple times, and you could be stuck with a higher interest rate. Interest rates are unpredictable and although rates are historically low now, that could change in the future.

Pros of an adjustable-rate mortgage

  • A lower initial interest rate and a smaller monthly payment, which allows borrowers to save more money or purchase a more expensive home.
  • If interest rates drop, borrowers can take advantage of them without refinancing. ARMs will automatically adjust periodically.
  • It's a cheaper way to buy a home if you know you won't be staying in it long term.

Cons of an adjustable-rate mortgage

  • Interest rates will periodically adjust and can become higher.
  • It's harder to maintain a budget when your monthly payment is not static.
  • ARMs are more complex and harder to understand than fixed-rate mortgages.

Which Should I Choose?

So, now that you know the advantages and disadvantages of fixed-rate mortgages vs. ARMs, the question is, which one is right for you? Here are a few questions you should think about when deciding which route you want to take.

How long will you be staying in the home?

If you're only planning to live in your home for a few years, an ARM could let you nab the lowest interest rate possible. If you sell before the initial fixed-rate period ends, or shortly after, you'll reap the benefits of a low rate without the risk of a rate increase. On the flip side, if this is your forever home, it could make more sense to go with a fixed-rate mortgage to provide stability and potential long-term savings.

What is the current rate environment?

When rates are high, an ARM makes sense. You can lock in a lower initial rate, and if rates fall, you have a chance of getting a lower payment without refinancing. When rates are low, it is usually better to go with a fixed-rate mortgage. You'll keep your low rate for the life of the loan, and you don't need to worry if rates rise over the years.

When does the ARM adjust and how frequently?

After the initial fixed period, most ARMs adjust annually, but some can adjust more frequently. Make sure you understand the terms of your loan and can handle the volatility of the adjustment periods you agree to.

What is your tolerance for risk?

ARMs can provide great savings, but there is a level of risk involved. Are you emotionally and financially prepared for it? If the unpredictability of fluctuating rates will cause your head to spin, a fixed rate might be better for you. And, more importantly, can you manage your budget if your mortgage payment goes up? Your mortgage payment can significantly change with an ARM, so be sure to think about whether you can take that on financially.

Fixed-Rate vs. ARMs: The Bottom Line

Both fixed-rate mortgages and ARMs have benefits and drawbacks. It's important to understand how these nuances can affect your finances and home ownership goals. Our loan experts are here to help you learn more and guide you toward the best option. Reach out to us today to get started!

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