Ever wondered about the intricate differences between an adjustable rate mortgage and a fixed rate mortgage, and which one might be better for you as a homeowner? Here is a look at the differences between the two, along with the pros and cons of each.
As you’ve probably guessed, adjustable rate mortgages (or ARMs) feature mortgage rates that are adjusted periodically to reflect current market conditions. You’ll most commonly see 5/1 ARMs, but there are also 3/1 ARMs, 7/1 ARMs, and 10/1 ARMs. The first number in the name represents how many years the fixed interest rate period lasts (so in a 5/1 ARM, that’s five years), while the second number represents how often the rate can change (so, every one year).
Lower initial interest rate. One appeal to adjustable-rate mortgages is that the initial interest rate is often lower. This means that you pay lower monthly payments initially, potentially allowing you to afford more house that you would with a fixed-rate mortgage. People who are buying a house in a place that they don’t plan on staying in for very long find this type of mortgage appealing.
Potential for interest rate to go down. The interest rate for an adjustable rate mortgage doesn’t necessarily go up after the fixed rate period ends. Depending on the timing of your mortgage, you might see your rates go down, making for even lower monthly payments.
Uncertainty. With an adjustable rate mortgage, there is, of course, more uncertainty with how much interest you’ll be paying each month. Some homeowners prefer a fixed rate mortgage for this reason.
Potential for interest rate to go up. Of course with the potential for your interest rate to go down after the fixed rate period ends, there is also the potential for it to go up. Your interest rate could increase enough that it is higher than what you would have paid on a fixed rate mortgage.
A fixed rate mortgage, as you can guess, has an interest rate that remains constant through the life of the loan.
Stability. A fixed rate mortgage makes it much easier to predict how much you will be paying for your mortgage in the coming months and years. This can ultimately make for simpler and smarter budgeting in the long-term.
Safe from unexpected rate increases. Even if mortgage rates unexpectedly rise up to 15 percent or more, you won’t be seeing any surprises in your monthly mortgage payment.
Higher initial interest rate. Fixed rate mortgages tend to have a higher initial rate than adjustable rate mortgages. This might limit how much house you can afford initially, and it could put added stress on your budget, especially if you’re a first-time homebuyer.
Hard to take advantage of lower interest rates. If you’re on a fixed rate mortgage and want to take advantage of lower interest rates, you’ll have to refinance. While refinancing can be a good decision for you as a homeowner, it is important to factor in those added closing costs and hours you’ll spend doing paperwork to take advantage of the lower rate.