Do you plan to buy a home or refinance the mortgage on your current one? If so, you have a number of important decisions to make, including whether to choose a fixed-rate mortgage (FRM) or an adjustable-rate mortgage (ARM). How do these options differ? And which should you choose? Here’s what you need to know to make the right call.
FRMs vs. ARMs
First off, what do these two terms mean in a practical sense? Fixed-rate mortgages are what most Americans would see as a traditional mortgage. The interest rate is set when you sign up for the loan and remains the same for the length of the term. Your payments generally don’t change except the portion of any payments that go toward taxes or insurance.
On the other hand, ARMs start with one interest rate for a set period of years. This rate is usually lower than a traditional fixed-rate loan. However, after that set period, the rate is adjusted — higher or lower — based on market rates, usually on an annual basis. Each loan contract specifies the initial low interest rate period and how often rates will adjust afterward.
The Pros and Cons of Fixed-Rate Mortgages
The pros of fixed-rate mortgages are generally in their stability. When you sign up for the loan, you know what interest rate will be charged and what the payment will be each month (for principal and interest). This makes them the easiest to budget for each month and to pay without interruption. You have no surprises.
However, fixed-rate loans don’t adjust for any new circumstances in life. If interest rates go down later, you will have to refinance to take advantage of that — which costs money and time. On the other hand, if you can only afford a lower payment now but expect your earning power to improve, you may be locked out because the fixed payments are set only once.
The Pros and Cons of Adjustable-Rate Mortgages
Adjustable-rate mortgages can be a good deal for borrowers who plan to pay off their loan more aggressively. In a normal economic environment, interest rates tend to adjust upward over time. Fixed-rate loans account for this when setting the initial rate while adjustable-rate loans don’t. So if you only need a loan for a short period of time — often 5 to 10 years — you will get a better rate for these initial years.
Keep in mind, too, that the adjustable-rate mortgage may adjust up or down depending on the economy. This can be a benefit of ARMs because if rates go down, your loan payments automatically adjust for this without effort or expense on your part. You don’t need to refinance to benefit.
Unfortunately, there’s no way to know what the future will hold. And if interest rates go up, as is more common, your payments will rise as well. In this scenario, you could end up spending significantly more in interest over the life of a 20- or 30-year mortgage. For this reason, many borrowers plan from the beginning to refinance if their loan starts to become more expensive.
Where to Learn More
Clearly, both types of mortgage loans are advisable in different situations — both personally and globally. If you plan to buy a new home, the best way to choose the right loan option is to learn more about how they work.
The mortgage lending professionals at Dominion Capital Mortgage Inc. can help. Call today to speak with our team and get your questions answered. Then, you can begin planning the best way to buy your new abode without breaking the bank.