Comparing Fixed-Rate and Adjustable-Rate Mortgages
For some home shoppers, deciding between a fixed-rate mortgage and an adjustable-rate mortgage is an easy decision. However, you may be surprised to hear about benefits of the option that you thought you did not want.
Depending on your situation, choosing either a fixed-rate or an adjustable-rate mortgage (ARM) can reduce the cost of homeownership and accelerate the time it takes to own the home free-and-clear.
Your current budget and future plans should make the decision an easy one.
Look at current mortgage rates and weigh cost-savings to determine whether a fixed-rate or adjustable-rate mortgage is right for you.
Fixed-rate mortgages are the most popular option when it comes to home loans. Over 90% of home buyers will pick a fixed rate over an ARM.
The Federal Housing Administration (FHA) created fixed-rate mortgages to make homes more easily affordable. Since the rate is fixed, your monthly payments won’t increase during the life of the loan.
The stability of a fixed rate makes it easier to create a long-term budget compared to doing the same with an ARM. Most borrowers today like the combination of a low rate plus stability that a fixed mortgage provides.
And with rates hovering at historic lows, mortgage shoppers can’t go wrong by choosing a fixed rate.
Yet, homeowners will discover they can create more room in their budget by opting for an ARM due to rates that are even lower than those for fixed-rate loans.
Adjustable-rate mortgages work differently than fixed-rate mortgages in a number of ways.
While a fixed-rate mortgage has a fixed rate throughout the life of the loan, an ARM has a fixed rate for a certain number of years. After that, the loan begins to adjust to any changes in mortgage rates.
For example, a five-year ARM will give you fixed rates for five years. After that, your rates will adjust depending on “caps.”
Interest rate caps represent a fixed amount that your mortgage rate can change throughout the life of the loan.
For example, if you have an ARM with a 5/2/5 cap, your rate cannot change by more than 5% after the fixed rate period ends. After that, your rate cannot change by more than 2% each adjustment period. Lastly, you mortgage rate cannot change by more than 5% over the life of the loan.
Rates for ARMs are consistently lower than those for fixed-rate mortgages, so the initial mortgage rate tends to be easy on budgets. After the initial period of your ARM ends, rates can jump higher, meaning higher monthly payments. However, rates can also decrease with an ARM, meaning lower payments.
A home buyer should consider an adjustable-rate mortgage if they are more concerned with initial payments than with payments five years or more down the road. If you expect to sell your future home in five or six years, an ARM could be a big money saver since you can avoid potential increases in monthly payments once rates adjust.
Also, there are a number of different options when it comes to ARMs. Your initial fixed period can be anywhere from three to seven years.
There might be an ARM that fits your long-term plan.
Current Mortgage Rates
Mortgage rates this year have been much lower than Wall Street expected. This has made home buying incredibly affordable.
Before applying for a home loan, be sure to check current rates for fixed- and adjustable-rate mortgages.