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When getting a mortgage, it can feel like you’re learning a new language. You want a basic understanding of the many terms that can be thrown around so that you know you’re making the best choices to afford your home.
Among these terms are two important ones that relate directly to your mortgage’s interest rate — adjustable-rate or fixed-rate mortgage.
We’ll help you understand the difference, as well as the considerations that can help you understand which one is right for your situation.
What is an Adjustable-Rate Mortgage?
An adjustable-rate mortgage, otherwise known as an ARM, involves getting an interest rate for a home loan that changes over time, affecting the cost of monthly payments. Homeowners often choose an ARM because the initial interest rate is lower than a fixed-rate mortgage, making it easier to initially afford buying a house.
The rate will likely increase over time though, as it changes based on the index it is tied to. Indexes are interest rates set by the changes in the market that are published by a neutral third party. There are several different indexes that a lender may choose, which is communicated to a homebuyer in their loan paperwork.
The changes in interest rate will cause monthly mortgage payments to change as well, throughout the lifetime of the loan.
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What is a Fixed-Rate Mortgage?
With a fixed-rate mortgage, your interest rate will stay the same for the entire lifetime of the loan. This makes it a more popular home financing option, as it provides consistency to homeowners who know they will pay a consistent rate throughout the term of their loan.
For monthly mortgage payments, the interest costs will be one consistent amount that doesn’t fluctuate.
The interest rate and balance you pay toward the principal will stay the same. Your other home expenses, such as property taxes and homeowner’s insurance may change as these costs are not controlled by your lender.
Among the many differences between these two options, there is something they have in common. Both an ARM and a fixed-rate mortgage offer options for the term of a mortgage, or the length of time you have to pay off your loan. The most common options are 30-year and 15-year mortgages.
Which One is Right for Your Situation?
When deciding if an adjustable-rate or fixed-rate mortgage is best for your situation, it may help to ask yourself the following questions:
How Much Mortgage Can You Afford Right Now?
The benefit to getting an ARM is that the interest rate may be lower when you first get your mortgage, meaning you can afford more house upfront. With a fixed-rate mortgage, the starting interest rate is often higher than an ARM but that rate will not fluctuate and increase throughout the life of a loan as an ARM might.
How Long Do You Plan to Own the Home?
If you’re not in it for the long haul then you won’t take on as much risk by getting an ARM. If you can get an ARM with a lower interest rate you’ll have a lower monthly mortgage payment over the short timeframe that you own the house.
Paying less each month, means you can save money for other expenses or for buying your next home.
When you sell your home in a few years, you can pay off your mortgage before possibly having to experience an increase in your interest rate.
If Interest Rates Rise, Can You Afford Monthly ARM Payments?
You’ll want to calculate the maximum rate that your mortgage could hit with an ARM to know if it happened whether you could still afford your mortgage payments.
When interest rates can reach almost 12% for example, that can get quite costly when applied to the large balance of a mortgage. Fluctuations such as these can make the certainty and stability of a fixed-rate mortgage more appealing, and sometimes even more financially sound than having an ARM even for a few years.
How and When Do ARMs Change?
ARMs are established with a fixed rate for a number of years. A common agreement for example, is a 5/1 ARM where the initial interest rate is fixed for five years. In the sixth year and beyond, the interest rate can change once a year, causing an increase or decrease to monthly mortgage expenses. There are also options for 3/1, 7/1, and 10/1 ARMs.
How Much Can Interest Rates Change?
Although they can be unpredictable, interest rates tend to trend up or down over cycles that last several years, giving you an idea of where they might be headed.
When rates are relatively low in general, fixed-rate mortgages can be more sensible. When rates are relatively high, ARMs can be beneficial because their lower initial rates help people afford homes more easily.
As rates fall, home buyers have a chance at getting lower monthly mortgage payments, even without having to refinance their existing mortgage.
Discuss Your Adjustable-Rate or Fixed-Rate Mortgage Options with Homefinity
Now that you’ve learned the basics about adjustable-rate mortgages compared to fixed-rate mortgages, speaking with a Homefinity loan officer can help you understand what the best option is for you.
Call us today to learn what your fixed interest rate would be or if you can start with a lower rate through an ARM to help you get into a home you can afford.
Photo by Austin Distel on Unsplash