Fixed vs Adjustable: The Rate Debate
Some people prefer stability and predictability with their mortgages. Others may be in a situation where flexibility is key. The good news is both parties can find a mortgage to fit their needs thanks to a Fixed-Rate or Adjustable-Rate Mortgage.
With today’s mortgage interest rates still clinging to historic low levels, it’s a very good time to buy or refinance a home. You want the lowest possible rate you can get when it comes to any type of financing, but especially with home loans because there’s so much money involved — even a tiny rate difference can make it a lot more expensive when borrowing money.
As you can tell by the names of both Fixed and Adjustable options, the interest rate plays a big part in how they work. But they’re very different. With either loan, even with an extremely low interest rate, you need to be very careful to choose the right one. They work differently. They’re designed for different purposes. Choosing the wrong loan could create financial difficulties down the road. Fortunately, it’s easy to tell them apart and make the right choice.
Here’s the most important difference between the two loans:
Key Point 1
With an interest rate that does not change, Fixed-Rate loans allow you to enjoy stable monthly mortgage payments throughout the life of the loan. There are variety of Fixed-Rate loans available, and all feature the same benefits:
30-year and 15-year Fixed-Rate loans are the most common Fixed-Rate loans.
30-year Fixed-Rate Loan:
15-year fixed-rate loan:
One disadvantage to a Fixed-Rate loan is if the rates drop, you’re stuck with that rate. But as low as they are today, getting a Fixed-Rate loan to buy or refinance a home isn’t much of a risk at all. In fact, it’s a good bet.
Key Point 2
ARMs have an interest rate that will vary, or adjust, over the life of the loan. They begin with an introductory period during which the rate does not change, that is actually lower than a Fixed-Rate mortgage. Typically, this period ranges from one to 10 years. After this time, the rate can change. It will go up or down to reflect or match where the current market rates are overall.
If you get an ARM with rates where they are today, you’d have a mortgage with an extremely low interest rate and monthly payments. But if, or when, they go up before your rate is scheduled to adjust, you could experience a dramatic increase in your monthly payments. It’s a very good loan if you use it for the right reasons.
The most common types of Adjustable Rate Mortgages are the 3/1 ARM, 5/1 ARM, 7/1 ARM, 10/1 ARM and the standard ARM.
The first number represents the introductory period when the interest rate is fixed and will not change. Afterwards, the rate can change once every year for the remaining term of the loan. For a 5/1 ARM, the interest rate stays the same for the first five years and can then change every year for the remainder of the loan. A standard ARM has an initial fixed-rate period of six months to a year.
When the rate on an ARM changes, it’s only applied to the remaining years and balance on the loan, not the original terms – so there are some savings to be captured there. There are also caps, or limits, to how high or low the rate can adjust each year, as well as over the life of the loan.
Benefits to getting an ARM:
Important considerations before getting an ARM:
With interest rates as low as they are, now is a fantastic time to buy a new home with either of these two loans. A Fixed-Rate mortgage will lock you into a rate with low payments you might not have to refinance in the future. Having an even lower rate during the introductory period of an Adjustable-Rate mortgage could help you save a bunch of money now while adjusting in the future.
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