As a consumer planning for a home purchase, one of the major decisions that you will have to make is deciding what type of mortgage will best meet your needs. In today's mortgage market, the types of mortgages available to you can be divided into two categories, adjustable and fixed interest rate mortgages.
Before discussing the benefits and pitfalls of adjustable and fixed rate mortgages, let's recap what the primary difference is between these two types of mortgages. A fixed rate mortgage is a mortgage where the interest rate and the monthly mortgage payments are fixed to a specific amount for the entire life of the loan. An adjustable rate mortgage, however, is a mortgage where the interest rate can fluctuate throughout the life of the loan. Because the interest rate in an adjustable rate mortgage can change, the monthly mortgage payment can also change.
Many consumers opt for fixed rate mortgages when buying a home because of the peace of mind that these types of mortgages provide. With a fixed rate mortgage, you can rely on the fact that your monthly mortgage payment will be the same every month for the life of your loan. This peace of mind, however, comes at a cost. Fixed interest rate mortgages typically have higher interest rates than adjustable rate mortgages. This higher interest rate means that, you will typically be paying more each month than you would be with an adjustable rate mortgage. Because fixed interest rate mortgages typically result in a higher monthly mortgage payment, they can often make it difficult for some consumers to meet the financial requirements necessary to qualify for a home loan.
Choosing a fixed rate mortgage can be even more costly than most people think. The very benefit of knowing that your interest rate is locked for the entire life of your loan can sometimes be a disadvantage. Because interest rates always fluctuate, a good interest rate in today's standards could be much higher than the market interest rate in five years. In this case, with a fixed rate mortgage you will be overpaying interest. To avoid overpaying interest, you should choose a fixed rate mortgage when interest rates are at historical lows. You can use a mortgage calculator to experiment with your monthly mortgage payments with a fixed rate mortgage.
An adjustable rate mortgage, often referred to as an ARM, is a popular form of mortgage for consumers that plan to live in a home for only a few years before selling the home. Unlike fixed rate mortgages that have a constant interest rate over the loan's entire life, an ARM's interest rate fluctuates over time. Depending on the length of time you think you will stay in your home, you can choose between ARMs that have a fixed rate for as short as 1 year to as long as 10 years. ARMs typically have a substantially lower interest rate associated with them resulting in a lower monthly mortgage payment. This lower monthly mortgage payment makes it easier for many consumers to meet the financial requirements necessary to qualify for a home loan.
Choosing an Adjustable Rate Mortgage can be seen as a gamble because it can both benefit you as well as be dangerous to you. The benefit of an ARM to you is that the short term interest rate on an ARM is typically lower than the interest rate of a fixed rate mortgage. For example, If you plan on staying in a home for only 5 years, a '5 Year ARM' is a good idea because its interest rate will be much lower than a 30 year fixed rate loan and will cost you less. The danger of an ARM, however, is that if your plans change and you have to stay in your home for more than 5 years, the ARM's interest rate can suddenly change after the 5 year adjustment period, possibly making your monthly mortgage payment much higher and burdensome. You can use an adjustable rate mortgage calculator to experiment with worst case payments of an adjustable rate mortgage.
Choosing between an adjustable and a fixed rate mortgage depends on your needs. To help make this decision, you must decide for yourself if you will be purchasing a home that you will live in for a short period of time (less than 10 years) or a longer period of time. If you are purchasing a home for a short period of time, an adjustable rate mortgage is the right option. Your decision must also be based on how comfortable you feel with risk. If having a predictable monthly mortgage payment is more important to you than a lower monthly mortgage payment, a fixed rate mortgage is the right option for you.