What city or town do you want to live in? What features do you want in a home? What’s your price range? Anyone who has shopped for a home can tell you; there are lots of decisions to make. And once you finally find the perfect home, there’s a whole new set of tough decisions to ponder – the mortgage decisions. One decision you will undoubtedly need to make is: Do you want a fixed- or adjustable-rate mortgage (ARM)?
Different options — and benefits.
To find the answer that’s best for you, you first have to understand how fixed- and adjustable-rate mortgages work. A fixed-rate mortgage allows you to lock in a fixed interest rate for a fixed period of time or term. For example, if you choose a 30-year, fixed-rate mortgage, your interest rate will remain the same for 30 years — no matter what the rate environment. This gives you the benefit of fixed monthly principal and interest payments that make budgeting easier.
When rates are higher, you’ll be protected from having your mortgage payment increase. However, when rates are lower, you will only be able to lower your rate by refinancing your mortgage.
In contrast, with an ARM, you will lock in a fixed rate only for an initial period, usually, 3, 5, or 7 years. After that period, your mortgage rate may adjust each year depending on the adjustment period. For example, if you chose a 7/1 ARM, your rate will be fixed for seven years. After that initial period, your rate could adjust upwards or downwards each year, depending on the rate environment during the adjustment period. The benefit of ARMs is that you will pay a lower rate of interest during the initial period.
If interest rates are lower during the adjustment period of your ARM, your mortgage payments will be automatically lowered. However, if interest rates are higher, your rate and your payment will increase, making them riskier than fixed-rate mortgages.
Choosing the option that’s right for you.
So, with such different features and benefits, how do you know which one is right for you? The answer lies in your answers to a few questions. Yes… more questions…such as…
- How long do you plan to live in the home? If you plan to stay in your home for a long time, a fixed-rate mortgage might be a better choice. You won’t have to worry about rising rates. If, however, you plan to stay in your home for just a few years, you may want to choose an ARM, which would allow you to get a lower rate in the early years and sell the home before the adjustment period.
- Do you expect your income to rise over time? If you expect your income to rise in the next few years, you may want to choose an ARM. An ARM will make your payments lower in the beginning, but if your income rises, you may be able to afford the adjustments.
- What’s happening with rates? If rates are higher when you apply, you may want to choose an ARM. The lower rate an ARM offers may make it easier for you to qualify and afford the home.
In short, the answer to what’s best for you depends on your preferences and comfort level. If you do choose an adjustable-rate mortgage, make sure to read the fine print and to understand when and how often your mortgage rate could adjust. Knowledge is power and will make any future decisions you have to make a whole lot easier.
Use our Mortgage Calculator to determine what your monthly payments might be, and other mortgage financing variables that could impact your situation.