Should You Choose a Fixed-Rate Mortgage or an Adjustable Rate Mortgage?
Updated: Nov 18, 2022
Choosing a home mortgage isn’t as simple as picking the first one that comes your way. While there are a variety of mortgages, the two most common loans are conventional/fixed-rate mortgages and adjustable rate mortgages. If you’re stuck between the two, read on to learn more about your options.
What is Fixed-Rate Mortgage?
A fixed-rate mortgage has an interest rate that remains the same for the entirety of the loan, which means that your total monthly payment of principal balance and interest won’t change. Your mortgage payments can fluctuate, though, if your property taxes or homeowners insurance rates shift. The repayment of a fixed-rate mortgage is available in 10, 15, 20, 30, and 40-year terms, but they most commonly come in 15 or 30-year terms.
What is Adjustable-Rate Mortgage?
An adjustable-rate mortgage (ARM), on the other hand, is an interest rate that can change periodically. ARMs are usually broken into ratios rather than years. For instance, take 5/1. In a 5/1 ARM rate, the introductory rate lasts for five years and then will change every year after that. Lenders can give 3/1 ARMs, 7/1, or 10/1 ARMs, but the most popular is 5/1.
An ARM follows rate indexes and margins to get the payment amount. The index is an interest rate set by market forces and published by a neutral party. There are many indexes, and the loan paperwork identifies which index a particular adjustable-rate mortgage follows. To set the ARM rate, the lender takes the index rate and adds an agreed-upon number of percentage points, called the margin. The interest rate can change, but the margin does not.
The Biggest Difference Between Fixed-Rate and Adjustable-Rate:
Fixed rates are “the most popular” type of financing because it offers predictability and stability for your budget. If interest rates drop, though, you won’t benefit unless you refinance your mortgage. Fixed rates tend to have a higher interest rate than an adjustable-rate mortgage. Though, the low rate of ARMs is only for a brief period usually. You can find the pros and cons of each here.
Talk to your agent today to find out which mortgage rate is right for you.
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