One of the first choices a homebuyer will need to make is whether you want a fixed-rate or an adjustable-rate mortgage loan. The bulk of loans will fit into one of these two categories, however, there is a third option that will allow you to “hybrid” the two.
An adjustable-rate mortgage, (ARM): The interest rate of the mortgage adjusts periodically based on market conditions. For example, your payment will go up if rates go up and go down if rates go down. Fixed-rate Mortgage: Unlike an adjustable-rate mortgage the interest rate is set at the time you take out the loan and will not change. Fixed-rate home loans can be 10 years, 15 years, 20 years or 30 years fixed. 30-year fixed is the most common because it allows your mortgage payment to be the lowest. Hybrid ARM: Features an initial fixed interest rate for a certain amount of time and then becomes an adjustable-rate for the remainder of the term. Standard terms are 3, 5, 7, or 10 yrs.
What is the difference between a fixed-rate and adjustable-rate Loan Program?
The difference between a fixed rate and an adjustable rate mortgage is that, for fixed rates the interest rate is set when you take out the loan and will not change. With an adjustable rate mortgage, the interest rate may go up or down.
Many ARMs will start at a lower interest rate than fixed rate mortgages. This initial rate may stay the same for months, one year, or a few years. When this introductory period is over, your interest rate will change and the amount of your payment is likely to go up.
Part of the interest rate you pay will be tied to a broader measure of interest rates, called an index. Your payment goes up when this index of interest rates increases. When interest rates decline, sometimes your payment may go down, but that is not true for all ARMs. Some ARMs set a cap on how high your interest rate can go. Some ARMs also limit how low your interest rate can go.
Fixed Rate Loans: Steady and Reliable
It should come as little surprise that the consistent rate and reliable mortgage payments of a fixed rate loan makes it the most popular choice for first time buyers. Knowing that your rate and payment will stay the same for the next 15 or 30 years makes financial planning and household budgeting simple and easy.
However, if you only plan to stay in your home for 5 to 10 years, a fixed rate may not make sense for your financial goals. This is because a fixed loan comes with a rate that is often higher compared to an adjustable.
While various fixed rate options are the choice for many borrowers, there is another option. For buyers who want to pay down their principal balance rapidly, and pay off their home quickly, a shorter term mortgage can help them do just that. With a shorter term, you can own your home free and clear in quicker than compared to a longer term mortgage. That means a potential savings of thousands, or even tens of thousands, of dollars in interest payments. A shorter loan term option is usually available at a lower interest rate than a longer term, although the total monthly payment will be higher.
Who it’s for:
- Borrowers who want a simple, easy to understand loan.
- Borrowers who want the stability of consistent rates and payments.
Adjustable Rate: a Powerful Tool for Short-term Savings
The interest rates of an adjustable rate mortgage (ARM) can offer a compelling alternative mortgage option for certain borrowers. For the initial interest rate period a borrower can save hundreds of dollars each month compared to a fixed rate loan, which may add up to tens of thousands of dollars during that period. For some borrowers, that means more cash for investments. For other borrowers, an ARM is a tool that allows them to qualify for more house compared to a fixed rate loan. They believe the extra square footage and hardwood floors are worth the risk that comes with an adjustable mortgage. For others, these loans make sense if you know that you only plan to stay in the home for a short period of time.
At the end of the initial fixed period, an ARM will adjust either up or down, depending on the financial index that it’s tied to. There is a chance that the interest rates will have dropped, and you will get the benefits of a lower rate without having to refinance. On the other hand, there is a very real risk that the interest rates will be higher. That means a higher rate and higher monthly mortgage payment.
Once you enter the adjustable period of your ARM loan, your interest rate can adjust every year. While there are caps (limits) to how high your rate can adjust initially, each subsequent year, and even a lifetime limit… you could still be facing rates and payments double of what you started with.
Not knowing where the rates will go, or what your housing costs could be next year, can make it difficult to do any kind of long-term financial planning.
The attractive initial rates of an ARM can make it a powerful tool for buyers who fully understand the pros and cons of this type of loan, and the details of a more complicated loan program.
Who it’s for:
- Borrowers who want to free up cash to reach short-term financial goals.
- Borrowers who want to qualify for larger mortgage amounts to afford more home.
- Borrowers with short-term plans to sell and move up to a larger home, or plans to eventually relocate.
What Type should I get?
You can shop for mortgage quotes quickly and easily on Clifton Saunders Mortgage Team. Our Purchase Assistants will help narrow down options based on your individual needs. It’s quick, it’s easy, and the more questions you answer – the more accurate your results. You’ll receive the Purchase information you need instantly without all the calls and emails.