Fixed Rate vs. Adjustable-Rate MortgagesMarch 30th, 2016
Of all the decisions you have to make when you buy a house, one of the most difficult – or at least confusing – can be figuring out what kind of mortgage to take out.
The good news here: you only have to decide between two basic types of mortgages.
One of them is called a fixed-rate mortgage. The other is known as an adjustable-rate mortgage, or ARM.
There are a few varieties of fixed-rate mortgages and ARMs, but the general difference between them is:
- The interest rate tied to fixed-rate mortgages is set when you take out the loan and doesn’t change.
- The interest rate for ARMs, on the other hand, can go up or down over time, depending on economic conditions.
With those basic details out of the way, here’s some more information about both kinds of mortgage loans as well as how you can decide which one is best for you.
Benefits of Fixed-Rate Mortgages
First, interest rate and payments are constant throughout the term. No matter what happens in the broader economy, your mortgage bill won’t change. So, you can rest assured your budget won’t fluctuate wildly over the next 15, 20, or 30 years. (Those are the most typical fixed-rate mortgage lengths.)
Also, this kind of mortgage is a lot easier to understand than the ARM. And then there’s the fact that the particulars of these loans are very similar from lender to lender.
Downsides of Fixed-Rate Mortgages
Because you don’t get any early rate or payment breaks with these mortgages, some people find them unaffordable. This is especially true when interest rates are high.
Another potential negative: you have to refinance your loan if you want to take advantage of dropping interest rates. Doing that takes time and money – thousands of dollars, in some cases.
Benefits of Adjustable-Rate Mortgages
Probably the best thing about ARMs is the payments associated with them can be low. At least initially. That’s attractive to a lot of people – especially those who don’t plan on staying in that home for very long.
It also allows some folks to obtain a larger loan than they’d qualify for if they went for a fixed-rate mortgage.
Another positive: if interest rates drop after you take out an ARM, you can take advantage of them without refinancing.
Downsides of Adjustable-Rate Mortgages
These loans usually are more difficult to understand than their fixed-rate counterparts. If you don’t know what you’re getting into when you first apply for one, you may end up with a mortgage that isn’t right for your life situation.
The fact that the monthly payments related to these loans often change – sometimes wildly – over time is another downside. Seeing your interest drop is great, of course, but seeing it rise can be a nightmare. (Just imagine your rate jumping from 6 percent to 12 percent within a year or two, which is possible with some ARMs.)
How Do I Know if a Fixed-Rate Mortgage or an ARM is Best for Me?
Are stability and predictable payments important to you? A fixed-rate mortgage may be right for you, especially if interest rates are low.
An ARM may be a better bet, though, if you don’t think you’ll own the home for very long. The same is true if it seems like interest rates will plummet in the near future. When they do, you’ll be able to enjoy them without having to go through the hassle of refinancing.