When it comes to buying a house, one of the biggest decisions you will make is choosing the right mortgage. There are many different types of mortgages available, but two of the most common are fixed-rate mortgages and adjustable-rate mortgages (ARMs).
Let’s explore the pros and cons of each type of mortgage to help you make an informed decision when it comes to choosing between a fixed and adjustable rate mortgage loan. It’s pertinent to reiterate our quick disclaimer that everyone’s financial situation is different and you shouldn’t make financial decisions based on this or any other similar general-information blogs; so, please seek the advice of a licensed loan originator with your specific questions.
Fixed-rate mortgages are the most popular type of mortgage loan, and for good reason. With a fixed-rate mortgage, your interest rate remains the same for the entire term of the loan. This means that your monthly mortgage payment can be expected to stay the roughly the same (things like escrowed tax and insurance payments will likely introduce some fluctuations), making it easier to budget and plan your finances.
Thus, one of the biggest advantages of a fixed-rate mortgage is the peace of mind that comes with knowing what your mortgage payment will be each month. This can be particularly beneficial for first-time homebuyers who may be new to house budgeting and may be unsure of how much they can afford to spend on housing each month. Additionally, fixed-rate mortgages can be a good option for homeowners who plan to stay in their home for a long period of time, as they offer stability and predictability over the life of the loan.
On the other hand, adjustable-rate mortgages (ARMs) offer more flexibility (see below) than fixed-rate mortgages. With an ARM, your interest rate can fluctuate over the life of the loan, which means that your monthly mortgage payment can also change, sometimes quite dramatically. ARMs typically have a fixed interest rate for a set period of time, such as five or seven years, before the rate begins to adjust based on an index, such as the LIBOR or the Treasury bill rate.
One of the biggest advantages of an ARM is that you may be able to secure a lower interest rate and lower monthly payment initially than you would with a fixed-rate mortgage. This can be beneficial for homebuyers who plan to sell their home or refinance their mortgage before the rate begins to adjust. Additionally, ARMs can be a good option for homebuyers who anticipate an increase in income in the future and are comfortable taking on the risk of a fluctuating interest rate.
However, there are also several disadvantages to choosing an ARM over a fixed-rate mortgage. One of the biggest disadvantages is the potential for your interest rate and monthly payment to increase significantly once the rate begins to adjust. This can make it difficult to budget and plan for future expenses, and can even result in financial hardship if your payment becomes unaffordable. Additionally, if you plan to stay in your home for a long period of time, an ARM may not be the best option, as you will have less predictability over the life of the loan.
Another disadvantage of an ARM is the potential for negative amortization. Negative amortization occurs when the monthly payment is not enough to cover the interest that is accruing, and the difference is added to the principal balance of the loan. This can result in a higher overall cost of the loan and can make it difficult to build equity in your home.
So, which type of mortgage is right for you? The answer will depend on your individual financial situation and your plans for the future. If you are looking for stability and predictability, a fixed-rate mortgage may be the best option for you. On the other hand, if you are comfortable taking on some risk and are looking for a lower initial payment, an ARM may be a good choice.