Fixed Rate or Adjustable Rate Mortgage?

Fixed Rate or Adjustable Rate Mortgage?
  • Opening Intro -

    Like many home buyers today, you understand that mortgage rates are at tantalizing low rates.

    Choose an adjustable rate mortgage and you could shave one-half to a full point off of a comparable fixed rate mortgage, saving you a bundle of money.

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Though it is tempting to simply choose a mortgage based on the lowest rate, there are some things you should consider. Read on for a discussion about fixed rate and adjustable rate mortgages, and what each one has for you.

Mortgages Defined

Essentially, there are two main mortgages choices for you to choose from, with several smaller or less common choices available. We shall dispense with the less known and embrace the common here.

A fixed rate mortgage offers an interest rate that remains the same for the entire mortgage term, which is typically 30 years. Shorter terms for 10, 15 and 20 years are also available. If your mortgage interest rate is 4.8 percent now it will stay at that amount until your loan is paid off. The advantage here is your monthly payment stays constant.

An adjustable rate mortgage is sometimes known as a variable rate mortgage. As its name implies, an ARM’s interest rate can fluctuate depending on the current mortgage rates of the day. Typically, you’ll start off with a lower interest rate, perhaps 4.3 percent or less when compared to the sample fixed rate mortgage given. That rate, however, will adjust at some point over the term of the mortgage.

Pros and Cons

Both ARMs and fixed rate mortgages offer several pros and cons.

With an ARM, your interest rate might suddenly jump if mortgage rates are higher when the loan resets. For example, a 5/1 ARM will give you a lower rate for five years with annual adjustments annually thereafter. The “pro” here is that you’ll save money in the short run, but the “con” is that you may pay more later on.

With a fixed rate mortgage, the “pro” is that your mortgage payment stays the same always. This can be especially beneficial as your salary increases and the percentage of your home costs decreases. The “con” here is that you could be hit with a higher interest rate than you want.

Decisions, Decisions

Why would someone choose the “insecurity” of an ARM? For a number of reasons. An ARM, however, is ideal for the homeowner that expects to move in a few years, before the mortgage resets. You’ll pay less money for your mortgage and sell your home before you’re hit with a higher payment.

An ARM can also enable you to get into the home you want, perhaps the home you can’t afford with a fixed-rate mortgage. Here, you might assume two things: your salary will increase year over year, making it easier for you to afford your lifestyle and the second point is that you would qualify for refinancing later on if rates rise too rapidly. Of course, this kind of thinking got a lot of people in trouble with the last housing bubble burst, so much caution needs to be exercised here.

Regardless of your mortgage selection, if your funds permit you to do so, you could contribute extra money each month to reduce your loan principal. That move will give you more flexibility later on if you choose to refinance your loan or allow you to pay off your mortgage sooner.

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Categories: Home Financing